What are the Key Lessons from the Book “What I Learned Losing a Million Dollars”?

“What I Learned Losing a Million Dollars” by Jim Paul and Brendan Moynihan is a frank and honest analysis that revisit the events and circumstances leading up to Paul’s $1.6 million loss and examine the psychological factors behind bad financial practices in several economic sectors.

Investors lose money in the markets either because of errors in their analysis or because of psychological barriers preventing the application of analysis. While most analytical methods have some validity while each have corner cases or certain instances in which they do not work, psychological factors can keep an investor in a losing position, causing him to abandon one method for another in order to rationalize the decisions already made. Paul and Moynihan’s cautionary tale includes strategies for avoiding loss tied to a simple framework for understanding, accepting, and dodging the dangers of investing, trading and speculating. The book won the 2014 Axiom Business Book award gold medal.

This book is a must-read for anyone who is starting out their stock market journey, existing traders looking for a deeper insight on physiological aspects and even business managers in general.

The author Jim Paul (1943–2001) was first vice president in charge of the Morgan Stanley Dean Witter & Co. International Energy Unit in New York City. During his twenty-five-year career in the futures industry, he was a retail broker, floor trader, and research director and served on the Chicago Mercantile Exchange Board of Governors and the Executive Committee.

The co-author Brendan Moynihan is an adjunct professor of finance at Vanderbilt University’s Owen Graduate School of Management, and managing director at Marketfield Asset Management LLC, where his understanding of markets and the media helps shape their macro views and allocations. Moynihan is also an editor-at-large for Bloomberg News, where he manages the popular column “Chart of the Day” and writes about the economy and Wall Street. He has been with the company since 2007 after spending more than twenty years on Wall Street as a trader and risk manager.

I highly recommend this book. The key points are meant as a preview and not a replacement for the original work. If you are intrigued after reading this, please consider purchasing the original book to get the full experience as the author intended it to be.

Key Points

The book is divided into two parts. The first half talks about the life of the author, his rise and fall in the markets leading him to bankruptcy. Second half emphasizes the psychology behind losing money and how traders end up internalizing external monetary losses.

There are as many ways to make money in the markets as there are people participating in them, all losses come from the same few sources. That is why understanding what not to do, is just as important as understanding what to do. The number one cause for losing large amounts of money is letting emotions cloud our judgment. The book emphasizes this one point in great detail with several examples of bad decisions made based on clouded judgment influenced by emotion and overestimation of our abilities (also see The Dunning-Kruger Effect).

Warren Buffett stated in a 1987 letter to Berkshire Hathaway shareholders, that “in the short run, the market is a voting machine but in the long run, it is a weighing machine.” This implies that the market can behave like an (often irrational) electoral contest in the short term, determining a company’s share price based on how popular or unpopular it appears at the time. When markets behave like a voting machine, people tend to ignore a business’ underlying fundamentals and are driven by a mix of speculation, economic data, investor sentiment, news/media, exogenous events, high frequency traders.

However, in the long run, the market typically acts as a weighing machine. Meaning, equity prices will eventually reflect the fundamental characteristics of a business, including a company’s earnings growth potential, financial strength, competitive advantages, and management quality.

Thus, especially short-term when the market is acting like a voting machine, many people place speculative positions (stock picks based on little or no thorough company, industry and market analysis), and some beginners get lucky, which can be dangerous for their mindset. Especially if it happens a few times in a row. Then we can get afflicted by confirmation bias, leading to think that our strong evaluation and decision-making skill lead to the success and this is again confirmed by the market and our short-terms wins. When we start attributing our success to our own skill, we start to make bolder and bolder moves until we lose it all.

In order to avoid this mental pitfall, we need to accept that we can lose or fail and that it most likely will happen, it is just a matter of when. We need to overcome what is called optimism bias. This bias leads us to think that we are e.g. less likely to be a crime victim than everyone else, or that we are less likely to get cancer or get seriously ill/injured. As long as we realize that it may happen to us, and accept this, we can create a set of principles and rules to significantly decrease the likelihood of it happening. Losing or failing big does not just happen to beginners, in fact the more successful we become, the more likely we are to become overconfident, “blind” to pitfalls and less prepared, and the harder it will hit us.

The author of the book (Jim Paul) had a super successful streak for years. Starting out in a small town in Northern Kentucky, he worked at a golf course as a youngster and was lucky enough to caddy for a rich person who flew him around to different golf tournaments around the world. In college he directly asked the fraternity leader for a pledge form and managed to skip the whole rush process. In the military he became the first master instructor at a second lieutenant rank, which was unheard of at the time. He then worked on trading index funds and sold for a hundred and forty thousand dollars the first year, which made him the top performer in the company that year. He then became governor of the Chicago Mercantile Exchange. He felt unstoppable.

He was attributing his success to his skill and felt that he was somehow special. This went on until his courage and ego continued to grow and then he lost everything. His fortune, his reputation, and his job, in one fatal attack of excessive economic hubris.

Three Techniques to Prevent This From Happening

• Make Decisions Before the Trade
  • In the the context of stocks, this means setting a rule for what price will cause you to sell, or what price will cause you to buy more.
  • Within a business it means having rules of when to e.g. stop failing projects before it uses too much capital. It could also mean having a pre-determined action plan such as when my company generates X amount of revenue, we will launch this new project. Setting a plan will prevent you from being tempted to start a new project earlier because you are caught up in the excitement, which would lead to more risk.
  • For life in general, it could mean determining up-front how much money do you would want to make before being satisfied, so that you can direct focus on other things. A lot of people do not have a goal in terms of the amount of money they want to have. They just keep wanting more and more, leading them to neglect most other areas of their lives. This tend to make us unfulfilled and unhappy.
    
    
• Never Justify Your Loss
  • When people ask “why is the market up or down”, they most often do not really want to know the reason why, they are typically looking for a justification for their loss. By justifying a loss through attribution to something external we are protecting our egos from feeling that we failed. This will only lead to further unhealthy behavior because when externalizing losses people tend to be more likely to bet additional money to win it all back (in poker terms: “tilting” or “full tilt“). Thus, admit and accept your mistakes first. Then, seek to improve and learn from your mistakes. Be brutally honest with yourself and ask yourself are you only looking to improve, or engage in a justification for your loss (often called “rationalization“). If it is the latter, stop what you are doing. Go for a walk outside and return when you are in a different (better) mental and emotional state.
    
    
• Understand That in the Moment You Will Be Blind
  As long as you stick to your clear, well-defined and pre-determined rules, you should be fine. When we learn to avoid personalizing of our successes and to set boundaries for our actions during emotional moments, we are well on our way to reducing the number of mental pitfalls and retaining our accumulated wealth.

The Differences Between Investing, Speculating, Betting and Gambling

• Investing is parting with capital in the expectation of safety of principal and an adequate return on capital.
• Speculating in its simplest form is buying for resale.
• Betting is about being right or wrong. It is an agreement between two parties where the party proved wrong about the outcome of an uncertain event will forfeit a stipulated thing or sum to the other party. For example, people bet on the result of an election or a football game.
• Gambling is a derivative of betting, it is actually a form of entertainment. To gamble is to wager money on the outcome of a game, contest, or event or to play a game of chance for money or other stakes. Gambling usually involves a game or event of chance.

With interest rates so low for so long, many “investors” have fallen prey to speculation, betting and gambling. There are many ways to win (or lose!) in the markets. Thus, it is critical is to be honest with yourself about what “game” you are playing.

Great Quotes from the Book

• “People make purchases for only one of two reasons: to feel better (satisfying a want) or to solve a problem (satisfying a need).”
  
• “Emotions are neither good nor bad; they simply are. They cannot be avoided. But emotionalism (decision making based on emotions) is bad, can be controlled, and should be avoided.“
  
• “Consider when a market position is profitable, but not as profitable as it once was. When that that happens, he becomes married to the price at which it was the most profitable. He denies that the move is over, gets angry when the market starts to sell off, makes a bargain that he will get out if the market moves back to that arbitrary point, gets depressed that he did not get out, and maybe even lets the profit turns into a loss, thus slipping again into denial, then anger, etc. He creates a chain reaction of loops that result in further losses.“
  
• “Success can be built upon repeated failures when the failures aren’t taken personally; likewise, failure can be built upon repeated successes when the successes are taken personally.“
  
• “I think the easiest way to lose success is to become convinced that you are successful.” – Herb Kelleher, CEO of Southwest Airlines
  
• “Smart people learn from their mistakes and wise people learn from somebody else’s mistakes.”

If you are interested to go deeper and learn more, we recommend tuning in to episode #29 with Brendan Moynihan on The Tim Ferriss Show (Podcast), see link below.