by Jim Paul
By that time my dad was in and out of the nursing home and had a full-time nurse at home. I was driving back and forth almost every weekend visiting him and watching him die. I would go one weekend and my brother would go the next. Finally, in August of 1984 he died.
So between August 1983 and August 1984, I lost all of my money, went $400,000 in debt, lost my membership, my job, my Board of Governor’s seat, my Executive Committee seat and both of my parents. I lost everything that was important to me except my wife and kids. That was not a good twelve months.
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I am not relating this story for your pity. I am relating it because it helps convey some important observations I made about the nature of loss. My losses in the market weren’t the same as the losses in my personal life. My gambling losses in Las Vegas weren’t the same as losses in the markets. All those losses were different from the loss of my parents, which was different from losing my Board of Governors seat.
Most people acknowledge that losses will happen regardless of the type of business venture. A light bulb manufacturer knows that two out of three hundred bulbs will break. A fruit dealer knows that two out of one hundred apples will rot. Losses per se don’t bother them; unexpected losses and losing on balance does. Acknowledging that losses are part of business is one thing; taking and accepting those losses in the markets is something else entirely. In the markets, people tend to have difficulty actively (as opposed to passively as in the case of the fruit dealer and bulb manufacturer) taking losses (i.e., accepting and controlling losses so that the business venture itself doesn’t become a loser). This is because all losses are treated as failure; in every other area of our lives, the word loss has negative connotations. People tend to regard the words loss, wrong, bad and failure as the same, and win, right, good and success as the same. For instance, we lose points for wrong answers on tests in school. Likewise, when we lose money in the market we think we must have been wrong.
The American Heritage Dictionary defines lose as: 1) To be deprived of through death, 2) To fail to win (i.e., lose a game; to be defeated). Most of the time lose or loss is associated with games. Somehow, the concepts profit and loss get confused with win and lose, and right and wrong. But if you lose as a participant of a game, you weren’t wrong; you were defeated. If you lose as a spectator of a game, you must have placed a bet (or expressed an opinion) on the game’s outcome and you lost money (or were wrong); but you were not defeated.
External vs. Internal Losses
There are many different types of losses. You can lose your keys, a game or contest, money, your mind, esteem, self control, your parents, a bet, a job, etc. However, all losses can be categorized either as: (1) internal; such as self-control, esteem, love, your mind, or (2) external; such as a bet, a game or contest, money. External losses are objective and internal losses are subjective. That is, an external loss is not open to subjective, individual interpretation; it is an objective fact. On the other hand, an internal loss is defined in terms of the individual (i.e., subject) experiencing it. In other words, a loss is objective when it is the same for me, you and anyone else. The loss is subjective when it differs from one person to another; when it is entirely a personal experience.
For instance, thousands of people die every day, but those deaths aren’t “losses” to everyone; only to those who are directly and personally (i.e., internally and emotionally) affected. This type of loss is an internal loss and is a function of, and created by, the feelings and reactions of the person experiencing them. This means the loss is subjective and definable only in terms of the individual experiencing it. On the other hand, when Kentucky loses a basketball game, it is no more of a loss for a member of the losing team than for a spectator in terms of it being an external, objective fact. Both people are totally outside the definition of the event itself. Anyone who was watching the game can tell you which team “lost” and everyone watching would tell you the same thing. An objective loss is impervious to how you feel about it or react to it. It’s not subject to anyone’s appraisal; it must be accepted without evaluation. The player and spectator just mentioned could personalize this external loss if they equated their self-esteem with the success or failure of the team. This would internalize an external loss.
Because people tend to regard loss, wrong, bad and failure as the same thing, it is little wonder that loss is a dirty word in our vocabulary. However, in the markets losses should be viewed like the light bulbs or rotten fruit mentioned earlier: part of the business and taken with equanimity. Loss is not the same as wrong, and loss is not necessarily bad. For example, consider exiting a losing position with a small loss, but before the loss got bigger. That was a loss, but it was a good decision. By the same token, a profitable trade based on a tip may be bad because of the dangers of following tips (i.e., the tipster may have incorrect information or he doesn’t tell you when to get out).
Market losses are external, objective losses. It’s only when you internalize the loss that it becomes subjective. This involves your ego and causes you to view it in a negative way, as a failure, something that is wrong or bad. Since psychology deals with your ego, if you can eliminate ego from the decision making process, you can begin to control the losses caused by psychological factors. The trick to preventing market losses from becoming internal losses is understand to how it happens and then avoiding those processes.
How Market Losses Become Internal Losses
The key to understanding how external losses become internalized lies in knowing the subtle differences between facts and opinions. The American Heritage Dictionary defines a fact as something that has been objectively verified. Facts are neither right nor wrong; they simply are. Opinions are personal assessments and are right or wrong depending on whether they actually correspond with the facts. Therefore, only opinions can be right or wrong; facts cannot. Right and wrong are inappropriate for the description of business operations and market participation, and so are the terms win and lose. Participating in markets is not about being right or wrong, nor is it about defeat; it’s about making decisions.
Decision-making is a process of reaching a conclusion after careful consideration; it is a judgment; a choice between alternatives when all the facts are not yet, and cannot yet, be known because they depend on events unfolding in the future. Therefore, decision-making is not a choice between right and wrong. In 20/20 hindsight decisions might be good or bad, but not right or wrong. With regard to the markets, only expressed opinions can be right or wrong. Market positions are either profitable or unprofitable, period. But due to the vocabulary quirks outlined above, it is easy to equate losing money in the market with being wrong. In doing so, you take what had been a decision about money (external) and make it a matter of reputation and pride (internal). This is how your ego gets involved in the position. You begin to take the market personally, which takes the loss from being objective to being subjective. It is no longer a loss of money, but a personal loss to you (i.e., someone you knew was on the airplane that crashed). 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. They confuse net-worth with self-worth.
The very use of the terms right and wrong when describing a market position or business dealing means: 1) an opinion has been expressed, which only a person can do, 2) the market position or business venture has been personalized and 3) any losses (or successes) are going to be internalized. Remember when I described the high from being right about the market on my $248,000 day? “I” had just made all that money for me and everyone else. “I” was so smart. I didn’t know it at the time, but the only thing “I” had done was completely personalize my position in the market.
The Five Stages of Internal Loss
It may seem
a bit strange comparing the loss of life to a loss in the market. Ordinarily, you wouldn’t think of a loss in the market as a life or death situation (although living through a million-and-a-half-dollar loss can sure make you think about the alternative). However, the stages people go through when experiencing a loss in the market are strikingly similar to the stages people go through when facing death. When my father was dying, a friend of mine gave me a book about people with terminal illnesses titled On Death and Dying, by Elisabeth Kublar-Ross. During interviews with 200 terminally ill patients, the author identified five stages terminally ill patients go through once they find out about their illness. One can see the same stages in most people facing personally tragic news, such as the death of a spouse or a child. I also think people experiencing any type of internal loss go through these stages. For the purposes of this book let’s refer to them as the Five Stages of Internal Loss. Below is a brief description of each stage and a reference to how I displayed the same characteristics when I was in the bean oil trade.
1. Denial
Upon receiving the news of being terminally ill, patients immediately responded, “No, not me. It can’t be true.” Some patients were observed “shopping around” for many doctors, looking for reassuring second opinions. Patients discounted doctors’ opinions that confirmed the original diagnosis and emphasized those that were more optimistic.
This is the same thing I was doing in September and October of 1983 when the bean oil position stopped going up and started down. I was losing money but denied that the market had really turned around. I was indignant That was the trade that was going to make me $10 million, remember? In October I knew that I was under water, but didn’t even know how far under I was. That is the personification of denial. If you can’t even, or don’t dare, sit down and calculate how much you’re losing in a position, but you know to the exact penny how much you’re making on your profitable positions, then you’re denying the loss. I also sought “second opinions” by asking other traders what they thought about the market. And, of course, I listened to the ones who were bullish and ignored those who weren’t.
2. Anger
When the denial stage cannot be maintained any longer, it is replaced with feelings of anger (e.g., rage, envy, resentment). The anger is displaced in all directions (e.g., nurse, family, doctor, treatment) and projected onto the environment at random. I vented a lot of my frustrations about the loss in the form of anger directed mainly at my family. For a while, Pat and the kids avoided me like the plague.
3. Bargaining
Unable to face facts in the first stage, and angry at people and God in the second stage, patients try to succeed in entering some sort of agreement that may postpone the inevitable from happening: “If God has decided to take me from this earth, and he did not respond to my angry pleas, he may be more favorable if I ask nicely.” In September 1983 I made a pact with myself that if the market rallied back to where it had been in late August I’d get out of the position. By November I was begging the market just to get my position back to breakeven. All I wanted to do was get back to where I was before I had put on the bean oil trade.
4. Depression
Depression is a complex psychological disorder and discussing it at length is beyond the scope of this book. Generally speaking, however, some of the symptoms of depression are: pervasive feelings of sadness, distancing yourself from loved ones, changes in appetite or sleep habits, loss of energy, inability to concentrate, indecisiveness and/or refusal to follow advice. While I never went to a doctor to see if I was clinically depressed, I had a lot of these symptoms in the fall of 1983. I was so consumed with the bean oil position that I couldn’t sleep through the night, skipped meals, lost fifteen pounds in four weeks and lost interest in all the things that I once had found enjoyable. I was constantly tired, couldn’t focus on my work and refused the advice of those who told me to get out of the market.
5. Acceptance
The patient finally resigns himself to the inevitable. In this stage, communication becomes more non-verbal. Kublar-Ross says acceptance is almost void of any feelings and is marked by resignation. There are patients who fight to the end; who struggle and keep a hope that makes it almost impossible to reach the stage of acceptance. The harder the struggle to avoid the inevitable death and the more they try to deny it, the more difficult it will be for them to reach this final stage. But they do finally reach this stage. Similarly, the trader finally faces up to the inescapable reality and “accepts” the loss; either because he “wakes up” and does something to get out of the position, or more likely, because someone or something else forces him to exit the position. In my case, it was the latter. Without force I never would have accepted, nor taken, the loss.
For terminally ill patients, the one thing that usually persists through all these stages is hope. Even the most accepting patients left open the possibility for some cure, the discovery of a new drug or last minute success in a research project. They showed the greatest confidence in the doctors who allowed for such hope and appreciated it when hope was offered in spite of bad news. This is the same hope I was relying on when the bean oil position was deteriorating. When I talked to other traders, I only paid attention to the opinions and the news that confirmed my position in the market.
The Five Stages of Internal Loss and the Market Participant
Once a person has personalized a market position and it starts to show a loss, he is uncertain when or how it is going to end (just like the person with the terminal illness is uncertain what’s coming next) and he goes through the Five Stages of Internal Loss. He denies it’s a loss. (“No way! Is the market really down there? Are you sure that’s not a misprint?”) It’s a profitable trade that just hasn’t gone his way yet. He gets angry at his broker and/or his spouse, and/or the market. After that he starts bargaining with God or the market — that if only he can get back to breakeven, he will get out of the position. Then he gets depressed about the losing position. Finally, acceptance comes either because he “wakes up,” the analyst finally puts out a sell recommendation, or the margin clerk blows him out of the position.
The market participant doesn’t have to move directly to the acceptance stage. He can loop back to denial after each and every temporary reprieve the market gives him. If the market rallies some, he thinks the market has finally turned. But when the market starts back down again, he slips back into denial, then anger and so on. With each temporary rally he has another opportunity to play out the stages and lose more money in the process.
Even if the position is a net profit, the trader or investor can go through the Five Stages. Consider when a market position is profitable, but not as profitable as it once was. When that happens, he becomes married to the price at which it was the most profitable. He denies that the move is over, gets angry when the market starts to sell off, makes a bargain that he’ll get out if the market moves back to that arbitrary point, gets depressed that he didn’t get out and maybe even lets the profit turn into a loss, thus slipping again into denial, then anger, etc. He creates a chain reaction of loops that result in further losses.
This is exactly what I did in the bean oil trade. Every time the market rallied, I felt relieved and assumed that the decline was over. Having survived each downdraft, I would start looking at the market as though I had just entered the position, and I would create new levels and parameters with which to monitor the market.
Discrete Events vs. Continuous Processes
Earlier in the chapter we saw that someone could actually internalize an external loss; the player or spectator could take the loss of the game as a personal matter, and internalize what is properly an external loss. Although someone could do it, it’s a little hard to imagine someone going through the stages of denial, anger, bargaining, depression and acceptance over a basketball game. Why? Because the game is a discrete event — an activity with a defined ending point. However, internalizing an external loss is a lot easier to
do with the other type of loss producing activity: a continuous process — an activity that has no clearly defined end. Losses from continuous processes are much more prone to become internalized because, like all internal losses, there is no predetermined ending point.
In a continuous process, the participant gets to continuously make and re-make decisions that can affect how much money he makes or loses. On the other hand, a discrete event (e.g., a football game, roulette, blackjack or other casino game) has a defined ending point, which is characteristic of external losses. A loss resulting from a discrete event is definitive and not open to interpretation. When I bet on a Kentucky basketball game and Kentucky loses, it is a discrete event and an external loss that I can’t really argue with. Or, if I bet on 21 black in roulette and the ball lands on 17 red, I lost — period.
The markets fall into the category of continuous process because market positions have no predetermined ending point. Granted, the market has a defined open and close for the day, but a market position continues beyond the market’s close and could go on forever. Even though a loss in the market is an external loss (since money is external, not internal), it is also the result of a continuous process and prone to becoming an internal loss. Why? In a continuous process there is no certainty of how or when the open market position will end. That uncertainty about the future triggers the Five Stages of Internal Loss, which means the loss has become internalized, personalized and subjective. Because a losing market position is a continuous process, nothing forces you to acknowledge it as a loss; there’s just you, your money and the market as a silent thief. So as long as your money holds out, you can continue to kid yourself that the position is a winner that just hasn’t gone your way yet; the position may be losing money, but you tell yourself it’s not a loss because you haven’t closed the position yet. This is especially true for stock market positions because when you own the stock outright, no margin call is going to force you to call a loss a loss.
