Sometime in my mid – 20’s, I got tired of living on corn flakes and ketchup packets. So using what time and money I had, I read up on finance books. I e-mailed all kinds of finance “gurus”. I borrowed money to attend trading seminars. And this is what happened:
How I Lost $5,000 in Around Three Months
It was a multi-step process:
- I put $1,700 into a penny stock, based on a variety of tips and “technical” analysis.
- The stock plummeted like a fat man in a Chinese parachute. Later I found out the company’s assets were seized, and one of the directors was a serial fraudster.
- I held on to that stock even as it went down, praying it would go back up. I ignored savvier friends, who assured me the last person who could make that happen had done the same with Lazarus.
- When the stock became worthless, I tried to make the money back fast – by pouring more cash into a variety of other bad stocks. Persistence is always rewarded, and don’t ever let anyone tell you what you can’t do.
- Because Will Smith was a lying piece of s**t in The Pursuit of Happiness, I lost all that money too. I amplified a $1,700 loss into around $5,000.
Now that I’m older, and have pills to calm me, I feel comfortable explaining what I learned from this.
I have to say these mistakes made me financially smarter, in addition to being a bitter, cynical person who looks at puppies and sees only animal sacrifice. Truly, active trading is a character building process.
Lesson 1: The More You Believe Your Theory, the More the Charts Will Magically Seem to Agree
If you’re a new investor, write this down and stick it somewhere you’ll see it every day:
Your facts are as theory laden as you wish your theories were fact laden.
The problem with newbies – which I was at the time – is that gullibility warps the evidence. When you want to believe that a particular stock will do well, every form of fundamental and technical analysis becomes an exercise in reassurance.
You’ll start to insist that the D/E or P/E or whatever magic ratio “proves” your theory. You’ll look at charts and see patterns where none exist.
You’ve already decided, as an article of faith, that stock XYZ will do well. And so you’ll cherry pick the details, obsessing over the good signs and ignoring the bad ones.
Solution – I don’t know, but maybe just being aware of the phenomenon helps. If you’re already inclined to like a stock, bear in mind that any kind of analysis you’re doing is mostly just trying to justify it to yourself.
This especially happens after you’ve lost a lot of money, and are trying to make it back. Which leads me to…
Lesson 2: The Effect of One Stupid Decision is to Make You Even More Stupid
The moment I lost money, half my brain cells yelled “I told you so” at the other half. Then I guess they got into a hell of a fight, and most of them died.
The most ridiculous thoughts came to mind – like how I’d effectively thrown my new computer out the window (I hadn’t even planned to buy one), or deprived myself of ever owning a car (as if $1,700 makes a real difference there).
None of it was logical. But I kept obsessing over the money, and every hour I fabricated more elaborate stories about what I’d “really lost”.
It sent me into a panicked fight or flight mode, and I chose fight.
I dumped even more money into stocks, and even tried some binary options trading. This time I was twice as reckless as before.
Think of how, when you lose at Blackjack, you sometimes double the bet on the next round, to make up for the loss. And because some part of your lizard brain thinks bad luck can’t possibly strike twice like that.
Solution – Never make financial decisions immediately following a huge loss. Give yourself time to cool off. Or you will screw it up again.
Lesson 3: Persistence is Rarely Rewarded
Finance is not like studying, or working out. You cannot overcome market forces with persistence and character.
This is why professional traders are emphatic about stop losses. The most common amateur mistake is to sell too quickly when a stock rises, and to hold on too long when it drops.
And while that sounds simple, it will feel different when you start trading. It’s the hardest thing in the world to let go, and accept that you’ve suffered an irrevocable loss. Think about your last bad ex-girlfriend; that’s exactly how strong – and damaging – the impulse to hold on is.
Solution – When I wake up in the morning, I remind myself that traffic will be bad, the meeting will be too long, and I will lose money on stocks. When it doesn’t happen I feel great. When it does, I was expecting it.
In short, perpetually brace yourself.
Lesson 4: Don’t Dismiss Failures as Bad Luck
Here’s what I didn’t tell you yet:
Before I lost that $5,000, I made some pretty good returns. And there will be periods in every trader’s life when this happens: every stock you pick will, by some miracle, take off on divine wings.
And this creates some strange impressions. Like the sense that your success is due to analytical skills or trading systems, and not at all luck.
I guess it’s because you’ve done nothing to actually earn that money, beyond clicking buttons. You’ll want to justify your newfound wealth, in a way that makes you feel good.
The first time you make a bad mistake though, this justification turns into a form of self-sabotage. You’ll refuse to believe that your “system” could be flawed, and chalk up your failure to bad luck. Because hey, it worked so well before.
So you’ll continue to make the same mistake again. And again. And again. Each time you’ll tell yourself “that was just an outlier, next time things will be normal”, and continue to lose more money.
Solution – When you crash after a string of successes, don’t blame luck. Rethink your system. Try to spot where you made a mistake, instead of dismissing it as a freak incident.
Lesson 5: Being Right Once Means Nothing
Here’s what really sucks about trading: every successful trade requires two right decisions.
If you buy at the right time, you might still sell at the wrong time. If you sell at the right time, you may have bought at the wrong time. If you want to be cynical, it’s a game where you have to win two consecutive coin flips to advance one step.
But we like to ignore that, because it’s psychologically unappealing. Value investors like to obsess over the buy decision, growth investors like to dwell on the sell decision.
I don’t know which is more correct; wait till the financial experts finish that debate (probably just after the sun burns out). What I do know for sure is this: the probability of a successful trade is not 50-50. The odds are – at least a little bit – stacked against you.
Solution – Put a portion of your portfolio in safe, passive investments. Once that’s settled, then you put money into riskier things (For more on what those safe things are, follow us on Facebook).
But be prepared to lose the money in a trading account. Manage your expectations, so you won’t overreact when you lose.
What are some painful lessons you’ve learnt from the stock market? We’d love to hear your experiences here.