The Reading Room

What I Learned Losing a Million Dollars

Jim Paul and Brendan Moynihan

Published: 2013, Columbia Business School Publishing

This book is a candid recollection and analysis of Jim Paul’s real-life story of not only making a million dollars but losing that fortune, and the psychological factors that ultimately led him to that situation.

The essence of the book can be summarised as “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.” The core philosophy behind this is that emotions have as big a role to play in the success or failure of the task at hand, as much as technical skill or even luck. And the intent with which the task is done is the distinguishing factor e.g., all card playing is not gambling and all stock purchases are not investments.

The first part of the book sets the scene where a young Jim Paul becomes convinced through various life experiences that a) it is not important what you do for a living but rather what you get paid for doing it and b) knowing the right people to get the job done will get it done. An unbroken string of successes leads to Jim Paul’s rapid rise from a “dirt poor country boy” to a commodities trader, to the board of the Chicago Mercantile Exchange and ultimately to be a self-made millionaire.

From making more than a quarter of a million dollars in one day to losing over a million in a span of a few days starts Jim Paul’s search for answers on how to make money. Initially, he struggles to reconcile the learnings he finds – “Diversify your investments” says John Templeton, “Concentrate your investments” says Warren Buffet. The second part of the book, thus, is a quest to search for answers on how not to lose money rather than on how to make money. A summary of some of the key learnings from this evaluation of mental processes, behavioural characteristics and psychological factors and the role of emotions in decision making is summarised below:

1. It is important to distinguish between internal loss (such as love or self-control, which are linked to an individual and totally subjective) and external loss (such as a game, contest or money, which are objective and not open to individual interpretation). For example market profits or losses are external, objective events but can become subjective if they are internalised by attaching emotions like self-esteem or ego.
2.  Once a loss is internalised, the stages one experiences are very similar to those of losing a loved one or facing death i.e. denial, anger, bargaining, depression and acceptance.
3. Losses from continuous events (where the participant makes and re-makes the decisions as there is no end point) are more susceptible to being internalised than discrete events (an activity with a defined ending point). Investing in markets is a continuous process and hence, despite a loss in the market by itself being external, it is the uncertainty of the future that can trigger the five stages of loss once the loss has been internalised.
4. “Most people who think they are investing are speculating. And most people who think they are speculating are gambling.” The distinguishing factor being that gambling creates risk while investing/speculating assumes and manages risks that already exist or could exist. What determines whether a person is investing, trading, speculating, betting, or gambling is the characteristics a person displays when engaging in the activity. Therefore, a professional gambler (whose intent is to make money and not to seek entertainment) is similar to a stock arbitrageur as they both deal with calculated risks. Activities like betting and gambling are suitable for discrete events but if they are applied to a continuous process (like investing in the markets) it can leave you open to enormous losses.
5. The authors also touch upon a number of psychological fallacies that people display when it comes to risk and probability including the Monte Carlo Fallacy, tendency to overvalue/undervalue wagers depending on the probability and the size, as well as confusing unusual events with low-probability events.

In essence, the authors narrow down on “emotionalism” i.e., decision making based on emotions as the most common reason for losses in the markets and what leads to herd instinct and becoming part of a psychological crowd. The authors summarise the mental state of someone in a crowd as having a feeling of invincible power, being almost hypnotised and thus highly suggestible in that state.

The last part of the book was the most enriching and full of analogies that can be applied not just to investing but to daily life. This part talks about having a simple framework, a plan, to avoid losses due to psychological factors. We often talk about having a target price for a stock we own. On exactly similar lines, the authors stress that before one enters the market, it is essential to know where (price), when (time) and why (new information) the position will have to be exited. Having a clear plan which first determines a stop loss, converts a continuous process into a discrete event, thereby maintaining objectivity once you are in the market. The authors also link this to Ayn Rand’s “Objectivism” philosophy which is to refrain from answering (or having an opinion) until you can think on the subject, nicely summarised by the authors as “think before you answer, if you even answer”. It is essential here to highlight that the authors stress the need for not just having a mental plan but to actually commit that plan to paper, similar to the Morgan Stanley example where the worst-case scenarios are written down in books called “blue books”.

Perhaps one of the most philosophical takeaways that I drew from the book was when the authors concluded by talking about a lockjaw poker player’s strategy i.e., one who never stays in the game unless they have a hand. This all boils down to having a structured plan and staying in the game only when the position is working for you, and thus, taking the loss and not worrying about it when it is not. And the importance of understanding the distinction between “perseverance because you think the idea is a good one, and perseverance because you think the idea is a good one.”

 

Swati Jain
November 2022