Who should read this book: Anyone that is feeling like they’re on their high horse should grab a copy. Also if you’re getting into any sort of trading or investment you will find this valuable. Although he focuses on commodities and the stock market, the book is largely about lessons learned in human psychology, desire and greed.
Jim Paul was raised in a small town in Northern Kentucky and eventually moved to become governor of the Chicago Mercantile Exchange. His story is full of success and failure. In the pinnacle of his trading career he actually lost $1.6 million, not just $1 million… in one trade.
He paints a cautionary tale of hubris and getting caught up in our own thoughts, disregarding clear warning signs and what happens when we take things a bit too far. Originally I heard about him via the Tim Ferris podcast and read it a while back, but it’s taken on new meaning for me as I’ve delved into the world of crypto trading in the past year. While he was focusing on commodities, the lessons apply across any financial market and high stakes decision making.
This is one of those books that can be either one of two things for people; an entertaining read, or a practical guide that potentially saves you from financial ruin. But hopefully it’s both.
As Jim says, “When I was a kid, my father told me there are two kinds of people in the world: smart people and wise people. Smart people learn from their mistakes and wise people learn from somebody else’s mistakes.” We’d be smart to learn from his advice on this one.
Six psychological fallacies that lead to self-sabotage in trading
- The first psychological fallacy is the tendency to overvalue wagers involving a low probability of a high gain and to undervalue wagers involving a relatively high probability of low gain.
- The second is a tendency to interpret the probability of successive independent events as additive rather than multiplicative.
- The third is the belief that after a run of successes, a failure is mathematically inevitable, and vice versa.
- Fourth is the perception that the psychological probability of the occurrence of an event exceeds the mathematical probability if the event is favorable and vice versa.
- Fifth is people’s tendency to overestimate the frequency of the occurrence of infrequent events and to underestimate that of comparatively frequent ones after observing a series of randomly generated events of different kinds with an interest in the frequency with which each kind of event occurs. Thus, they remember the “streaks”
- Sixth is people’s tendency to confuse the occurrence of “unusual” events with the occurrence of low-probability events.
Big ideas from the book:
Why people lose money
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.
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
The formula for failure is not lack of knowledge, brains, skill, or hard work, and it’s not lack of luck; it’s personalizing losses, especially if preceded by a string of wins or profits. It’s refusing to acknowledge and accept the reality of a loss when it starts to occur because to do so would reflect negatively on you.
Risks of betting/gambling as a continuous process
Betting and gambling are suitable for discrete events but not for continuous processes. If you introduce the behavioral characteristics of betting or gambling into a continuous process, you are leaving yourself open to enormous losses. In betting and gambling games, you wager and wait to see if you are right or to experience some excitement, respectively. Any resulting monetary losses are real, but they are also passive because the discrete event ends all by itself. On the other hand, a position in the market is a continuous process that doesn’t end until you make it end. If you “wager and wait” in the market, you can lose a lot of money.
Crowd vs. individual reasoning
The basic distinction between the individual and the crowd is that the individual acts after reasoning, deliberation, and analysis; a crowd acts on feeling, emotion, and impulses. An individual will think out his opinions whereas a crowd is swayed by emotional viewpoints rather than by reasoning. In the crowd, emotional and thoughtless opinions spread widely via imitation and contagion.
How to create a plan
Broadly speaking, the decision-making process is as follows: (1) Decide what type of participant you’re going to be, (2) select a method of analysis, (3) develop rules, (4) establish controls, and (5) formulate a plan. Depending on what your goals or objectives are on the continuum of conservative to aggressive, you will decide whether you are an investor or speculator, which in turn will help you decide what markets to participate in, what method of analysis you’ll use, what rules you’ll develop, what controls you’ll have, and how you will implement these things with a plan
My favorite quote:
Remember, participating in the markets is not about egos and being right or wrong (i.e., opinions and betting), and it’s not about entertainment (i.e., excitement and gambling). Participating in the markets is about making money; it’s about decision making implemented by a plan. And if implemented properly, it’s actually quite boring waiting for your buy/sell criteria to materialize. The minute it starts getting exciting, you are gambling.