2015 has been a tough year for most microcap investors as the whole space went through a correction and a period of low buying interest and liquidity. I had a tough year and I think I learned a lot from it. I read What I Learned Losing a Million Dollars a few months ago and I thought the story of Jim Paul was fascinating, especially in today’s market environment.
The book relates the life of Jim Paul, who started from nothing in a small Kentucky town and went on to become the governor of the Chicago Mercantile Exchange. After many successes, most of them due to luck, he began to think of himself as a genius and ultimately made a huge risky bet where he lost everything. That made him realize that there are a lot of resources on how to beat the market but not so many on how to avoid losing. He went on a quest to understand why people lose money in the market and how to fix these mistakes.
The book is divided in three parts. The first part tells the story of Jim Paul’s rise and crash. The second part goes over the most common mistakes investors make in the market. Finally, the third part presents solutions to fix these mistakes, such as having a very well defined plan before buying a stock and how to use stop-losses according to your initial plan. Although I am not a big fan of stop-losses, the theory made sense and it was interesting to learn more about this technique.
Paul realized that losses happen only for a few reasons; it might either be an error of analysis or a psychological bias that prevents the investors from applying common sense or proper analysis. He refers to the psychological biases as personalizing the market, which means that you take your results and the moves of the market as personal. Here is a quote from the book that illustrates well the concept:
An example of personalizing market positions is people’s tendency to exit profitable positions and keep unprofitable positions. It’s as if profits and losses were a reflection of their intelligence or self-worth; if they take the loss it will make them feel stupid or wrong.
Personalizing the market also happens when you give someone your opinion on the direction you expect a specific stock to go. If you are right, you will feel like a genius whereas if you are wrong, you might feel obligated to stick to your initial thesis and keep the stock (or even add to it to show your conviction) without proper analysis instead of admitting you might have made a mistake in the first place and accept the loss.
Personally coming from a poker background, I can tell you that psychological errors happen a lot and that this is probably one of the most underrated areas on which people try to improve. I believe that the same goes for stock market investment, and this book really underlines the major mistakes that one should try to avoid. I recognized myself in quite a few situations and was able to improve my mindset dramatically after reading the book. I highly recommend it.