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FOREWORD
Jack Schwager

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. Specifically, I use the following example: No sane person would walk into a bookstore (assuming you could still find one these days), go to the medical section, find 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, find a book with a title like How I Made a Million Dollars Trading 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 answer. 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

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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 successful 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 successful 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 profits and a good deal more. And Paul would be the first to admit that his winning streak was a matter of luck even though it lasted for years. This conclusion is unavoidable because his deficiency as a trader made a total loss inevitable. As he readily acknowledges, 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 differ 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 expert 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 filled with a wealth of trading wisdom and insights. It cost Paul a fortune to learn these lessons; the reader has the opportunity to benefit from this knowledge for the mere cost of a book—a true bargain.

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PREFACE TO THE COLUMBIA EDITION

Since this book was first 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 financial 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 markets. 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 first printing, we have witnessed some colossal risk-management disasters. For example, Nick Leeson of Barings Bank lost 827 million 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 Allfirst 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 euros ($7.4 billion) between 2006 and 2008 in equity derivatives.

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These highly publicized cases, and others, riveted media, management, and academic attention on the strategies and controls of the risk-management business. While the many postmortems offered 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 parable to point out the three biggest mistakes that investors and traders 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 identifies the mental processes, behavioral characteristics, and emotions that lead us into those losses. Then it offers a prescription for avoiding those processes, characteristics, and emotions—and the losses that accompany 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. Similarly, in this book the story is about a commodities trader, but its lessons 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; likewise, failure can be built upon repeated successes when the successes are taken personally. Thomas Edison failed roughly 10,000 times before finding the right filament 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 tomorrow.” 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

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nothing and in fifteen years had built the largest and most profitable manufacturing firm on the planet. Yet a few years later, this seemingly 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 personally 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 reflection of their abilities rather than the result of capitalizing on a good opportunity, 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, overconfidence, arrogance. But the way in which successes become personalized 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 entrepreneurs: 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 Buffettt, the richest man in America, is quoted on the cover of Forbes’s 1993 edition 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 between 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 presented in anecdotes about a real person and a really big loss. How big? The collapse of a fifteen-year career and the loss of over one million dollars in a mere seventy-five 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 knowledge 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 defective.” They are like racing fans making the same losing bet on an instant replay. Investors’ bookshelves are filled with Horatio Alger stories 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 fortunes, 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 beneficial, we’d all be rich. A review of the investment and trading literature reveals very little written about losing money. When something has been written on this topic, it’s usually a sensationalistic, unauthorized tell-all biography or tabloid-like exposé that panders to people who delight in the misfortune of others. Personality-journalism books are definitely read for entertainment, not as an attempt to learn from the subject’s mistakes. Losing has received only superficial coverage in most books on the markets; they raise the subject, stress its importance, and then leave it dangling. What I Learned Losing a Million Dollars is a light treatise on the psychology 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 psychology or psychoanalysis (i.e., sublimation, regression, suppression, anger, self-punishment). This isn’t to say such books aren’t instructive; it’s just that most people find 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, entertains and educates you on the psychology of market losses in layman’s terms, anecdotally, through the story of a trader who actually lost over a million dollars in the market. The first part of the book is Jim Paul’s personal odyssey of an unbroken 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 million 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 fifty-fifty; 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 variety 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 first 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 disillusioned. He set out on a quest to find 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 masters made money not only in widely varying ways but also in ways that contradicted each other. What one market pro advocated, another ardently opposed. It finally 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 markets, 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 application of the analysis. Most of the losses are due to the latter. All analytical 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 first 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 difficult 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 catastrophic 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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