One paradox I often pose to my audiences in talks about the elements of successful trading concerns the dichotomy in human thinking as it relates to trading versus everything else. Specifi cally, I use the following example: No sane person would walk into a bookstore (assuming you could still fi nd one these days), go to the medical sec-tion, fi nd a book on brain surgery, read it over the weekend, and then believe he could walk into an operating room on Monday morning and perform successful brain surgery. The operative word here is “sane.” Yet how many people do you know who would think that it is perfectly reasonable to walk into a bookstore, go the investment section, fi nd a book with a title like How I Made a Million Dollars Trad-ing Stocks Last Year , read it over the weekend, and then start trading Monday morning and expect to beat the professionals at their own game. Why this dichotomy in thinking?

The foregoing paradox is one that I believe has a satisfactory an-swer. Trading, as far as I know, is the only endeavor in which the rank amateur has a 50/50 chance of being right. Why? Because there are only two things you could do in trading: you can buy or you can sell. And, as a consequence, some portion of clueless beginners will get it right simply by chance— for a while . This potential for temporary success by pure luck beguiles people into thinking that trading is a

FOREWORD

Jack Schwager

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lot easier than it is. The potential for even temporary success doesn’t exist in any other profession. If you have never trained as a surgeon, the probability of your performing successful brain surgery is zero. If you have never picked up a violin, your chances of playing success-ful solo violin in front of the New York Philharmonic are zero. It is just that trading has this quirk that allows some people to be suc-cessful temporarily without true skill or an edge—and that fools people into mistaking luck for skill.

Jim Paul thought that his early success in the markets was caused by his being smart or maybe by his willingness to break the rules. He didn’t realize that his heady run was based on luck until he had lost all his profi ts and a good deal more. And Paul would be the fi rst to admit that his winning streak was a matter of luck even though it lasted for years. This conclusion is unavoidable because his defi -ciency as a trader made a total loss inevitable. As he readily acknowl-edges, even if had not lost all his money when he did, it would merely have postponed this ultimate outcome, perhaps to a point in time when his loss would have been that much greater.

The truth is that trading, both successful and unsuccessful, is more about psychology than tactics. As Jim Paul ultimately learns through a very expensive lesson taught by the market, successful trading is not about discovering a great strategy for making money but rather a matter of learning how to lose. From the research he conducts following his catastrophic experience in the markets, Paul realizes that winning traders diff er radically, using approaches that often contradict one another. What winning traders share, however, is that they all understand that losing is part of the game, and they all have learned how to lose. By losing everything, Paul becomes an ex-pert on losing, and it is only then that he can become a winning trader rather than a temporarily lucky one.

There is more to be learned from Jim Paul’s true story of failure than from a stack of books promising to reveal the secret formula for success. Not only that: What I Learned Losing a Million Dollars is a much more entertaining read. Although the book can be read simply as a humorous and breezy tale, readers should not lose sight of the

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fact that this compact volume is fi lled with a wealth of trading wis-dom and insights. It cost Paul a fortune to learn these lessons; the reader has the opportunity to benefi t from this knowledge for the mere cost of a book—a true bargain.

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Since this book was fi rst published, nearly twenty years ago, a lot has changed in the world of trading. Open outcry is nearly dead, exchanges have merged, and newfangled instruments have been created—some of which generated losses that brought the global fi nancial market to its knees.

One thing that has not changed over the past twenty years is the decision-making mistakes that traders and investors make in the mar-kets. Whether you are a professional managing other people’s money or an individual managing your own money, you are susceptible to these mistakes—if not on the same scale of operations. Since the book’s fi rst printing, we have witnessed some colossal risk-manage-ment disasters. For example, Nick Leeson of Barings Bank lost 827 mil-lion pounds ($1.4 billion) in 1995 betting on the Japanese stock market. Toshihide Iguchi of Daiwa Bank lost $1.1 billion the same year. Yasuo Haminaka, a.k.a. Mr. Copper, of Sumitomo lost $2.6 billion trading copper in 1996. Then there was John Rusnak at Allfi rst Bank, who lost $691 million in 2002 trading currencies. Chen Juilin of China Aviation Oil Corporation lost $550 million in 2005 trading jet-fuel futures (It was a spectacular fall from grace for the “King of Aviation Oil.”) And Jerome Kerviel of Societe Generale dropped a stunning 4.9 billion eu-ros ($7.4 billion) between 2006 and 2008 in equity derivatives.

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These highly publicized cases, and others, riveted media, man-agement, and academic attention on the strategies and controls of the risk-management business. While the many postmortems of-fered valuable lessons, mostly in the areas of internal controls and hedge-strategy selection, these autopsies have largely overlooked what went on inside the minds of the individual traders actually pulling the trigger on the trades. While lax controls may have enabled these losses to occur and questionable hedging strategies may have contributed to the losses, neither factor caused the losses; traders did. And to understand and prevent losses we need to get inside the mind of the individual. This book does that. I use Jim Paul’s story as a par-able to point out the three biggest mistakes that investors and trad-ers make every day in the markets. These have not changed and never will. The mistakes are timeless, and so are the lessons for avoiding them. I’ve talked to hundreds of traders and investors since the book’s publication, and to a person they’ve agreed with the premise of the book and the lessons it holds. This is because all of us lose money as some point; and the book simply identifi es the mental pro-cesses, behavioral characteristics, and emotions that lead us into those losses. Then it off ers a prescription for avoiding those pro-cesses, characteristics, and emotions—and the losses that accom-pany them. May the lessons teach and the stories entertain.

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Books can generally be categorized into one of three groups: education, entertainment, or reference. Education books teach us; entertainment books amuse us; and reference books inform us. This book combines education with entertainment to make it easier to recall the lessons by remembering the story. In that sense, this book is a parable: a simple story illustrating important lessons. From the story of the little boy who cried wolf to the story of the emperor’s new clothes, parables have been used to convey lessons that apply to many aspects of life. Simi-larly, in this book the story is about a commodities trader, but its les-sons apply to stock-market and bond-market investors, as well as all types of business people: entrepreneurs, managers, and CEOs.

The moral of the story you are about to read is: Success can be built upon repeated failures when the failures aren’t taken personally; like-wise, failure can be built upon repeated successes when the successes are taken personally. Thomas Edison failed roughly 10,000 times be-fore fi nding the right fi lament to make an electric light bulb. The day his Menlo Park laboratory burned to the ground a reporter asked him what he was going to do. Edison responded, “Start rebuilding tomor-row.” In part, Edison succeeded because he didn’t take failures or losses personally. On the other hand, consider Henry Ford, who worked with and greatly admired Edison. Ford started in 1905 with

PREFACE

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nothing and in fi fteen years had built the largest and most profi table manufacturing fi rm on the planet. Yet a few years later, this seem-ingly impregnable business empire was in shambles and would go on to lose money almost every year for the next two decades. Ford was known to stick uncompromisingly to his opinions; is it possible his company lost so much money because he took the successes person-ally and came to think he could do no wrong?

Personalizing successes sets people up for disastrous failure. They begin to treat the successes totally as a personal refl ection of their abilities rather than the result of capitalizing on a good oppor-tunity, being at the right place at the right time, or even being just plain lucky. They think their mere involvement in an undertaking guarantees success.

This phenomenon has been called many things: hubris, overconfi -dence, arrogance. But the way in which successes become personal-ized and the processes that precipitate the subsequent failure have never been clearly spelled out. That is what we have set out to do. This book is a case study of the classic tale of countless entrepre-neurs: the risk taker who sees an opportunity, the idea that clicks, the intoxicating growth, the errors, and the collapse. Our case is that of a trader, but as with all case studies and parables the lessons can be applied to a great many other situations. These lessons will help you whether you are in the markets or in business. The two areas have more in common than one might suppose. Warren Buff ettt, the richest man in America, is quoted on the cover of Forbes ’s 1993 edi-tion of the “400 Richest People in America”: “I am a better investor because I am a businessman, and I’m a better businessman because I’m an investor.” If the elements of success can be transferred be-tween the markets and business, the elements of failure can too.

We could study a hypothetical series of successes to demonstrate how success becomes personalized and then how a loss follows, but you are more likely to remember and learn the lessons if they are pre-sented in anecdotes about a real person and a really big loss. How big? The collapse of a fi fteen-year career and the loss of over one million dollars in a mere seventy-fi ve days.

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WHY A BOOK ON LOSING?

Almost without exception, anyone who has participated in markets has made some money. Apparently people have at least some knowl-edge about making money in the markets. However, since most people have lost more money than they have made, it is equally apparent that they lack knowledge about not losing money. When they do lose, they buy books and attend seminars in search of a new method of how to make money since that last method was “obviously defec-tive.” They are like racing fans making the same losing bet on an in-stant replay. Investors’ bookshelves are fi lled with Horatio Alger sto-ries of rags-to-riches millionaires. Sometimes these books are read solely for entertainment, but more often than not they are read in an attempt to learn the secret of how the millionaires made their for-tunes, particularly when those millions were made by trading in the markets. Most of these books are of the “how-to” genre, from James Brisbin’s 1881 classic The Beef Bonanza: How to Get Rich on the Plains to modern-day versions of how to get rich in the market: How to win in the market . . . , How to use what you already know to make . . . , How to apply the winning strategies . . . , How to make a million dollars in the market before breakfast . We’ve all read them, but if the “how-to” books were that benefi cial, we’d all be rich.

A review of the investment and trading literature reveals very lit-tle written about losing money. When something has been written on this topic, it’s usually a sensationalistic, unauthorized tell-all bi-ography or tabloid-like exposé that panders to people who delight in the misfortune of others. Personality-journalism books are defi -nitely read for entertainment, not as an attempt to learn from the subject’s mistakes. Losing has received only superfi cial coverage in most books on the markets; they raise the subject, stress its impor-tance, and then leave it dangling.

What I Learned Losing a Million Dollars is a light treatise on the psy-chology of losing and is intended for investors, speculators, traders, brokers, and money managers who have either lost money or would like to protect against losing what they’ve made. Most discussions of

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the psychological aspects of the markets focus on behavioral psy-chology or psychoanalysis (i.e., sublimation, regression, suppres-sion, anger, self-punishment). This isn’t to say such books aren’t in-structive; it’s just that most people fi nd it hard to digest and apply the information presented in those books. Other books use hypothetical character sketches to make their points while others simply compile a list of old saws about losses. This book, on the other hand, enter-tains and educates you on the psychology of market losses in lay-man’s terms, anecdotally, through the story of a trader who actually lost over a million dollars in the market.

The fi rst part of the book is Jim Paul’s personal odyssey of an un-broken string of successes that took him from dirt-poor country boy to jet-setting millionaire and member of the Executive Committee at the Chicago Mercantile Exchange before a devastating $1.6 mil-lion loss brought him crashing down. One of the premises of this book is that the rise sets up the fall; the winning sets up the losing. You can’t really be set up for disaster without having it preceded by success. If you go into a situation in a neutral position, having neither successes nor failures beforehand, you acknowledge that your odds are maybe fi fty-fi fty; you may have a winner, you may have loser. But if you start from scratch and have a run of successes, you are setting yourself up for the coming failure because the successes lead to a va-riety of psychological distortions. This is particularly true if you have unknowingly broken the rules of the game and won anyway. Once that happens to you, you think that you are somehow special and exempt from following the rules.

The seeds of Jim’s disaster were sown with his fi rst job at the age of nine. His exposure to the outside world, money, and material things was the foundation for his career’s sharp and quick ascent as well as its ultimate collapse. Repeated attempts to make the money back by speculating in the markets ended in failure and left Jim disil-lusioned. He set out on a quest to fi nd out how the pros made money in the markets so he could follow their example. When you’re sick you want to consult the best doctors; when you’re in trouble you want the best lawyers; so Jim read all about the techniques of the

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professionals to learn their secret of making money. But this search left him even more disillusioned since he discovered that the mas-ters made money not only in widely varying ways but also in ways that contradicted each other. What one market pro advocated, an-other ardently opposed. It fi nally occurred to him that studying losses, losing, and how not to lose was more important than studying how to make money.

The second part of the book presents the lessons Jim learned from his losing experience. Namely, there are as many ways to make money in the markets as there are people participating in the mar-kets, but there are relatively few ways to lose money in the markets. People lose money in the markets either because of errors in their analysis or because of psychological factors that prevent the applica-tion of the analysis. Most of the losses are due to the latter. All ana-lytical methods have some validity and make allowances for the times when they won’t work. But psychological factors can keep you in a losing position and also cause you to abandon one method for another when the fi rst one produces a losing position.

The third part of the book shows you how to avoid the losses due to psychological factors. Trading and investment mistakes are well known and easily understood but diffi cult to correct. What you need is not a long litany of complex psychological theories but a simple framework to help you understand, accept, and thereby avoid cata-strophic losses. This book will help you recognize, identify, and avoid the pitfalls of investing, trading, and speculating.

So, why a book on losing? Because, there are as many ways to make money in the markets as there are participants but relatively few ways to lose, and despite all the books on how to make money in the markets, most of us aren’t rich!

Brendan Moynihan Nashville, TN May 1994

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