by Jim Paul
Even though the following advice may seem to contradict everything this book has said about the need for a plan, I would be remiss if I didn’t give you this final lesson about the markets because I know you’re human, and I know you will deviate. If you deviate from your plan, break the rules, follow a tip, act on some intuition or gut feel, remember this: Speculating (and this includes investing and trading) is the only human endeavor in which what feels good is the right thing to do. We all know we shouldn’t smoke; a lot of us still do. We know we shouldn’t drink; a lot of us still do. We know we shouldn’t drive over the speed limit; a lot of us do. Why do we do all these things that are not good for us, and that we know are not good for us? Well, because they feel good. It feels good to drink and smoke and drive fast. But ever since we were little kids we have been told not to do things that feel good. When it comes to the markets you’re supposed to do what feels good. If you deviate from your plan and the market starts going against you, what are you going to say when I knock on your door and ask, “Well? Are you having fun? Is this an enjoyable experience?” You’re going to say, “No! This is not fun. Looking at these prices going down is not fun.” You know what you should do? Don’t go looking for supporting evidence or reasons to stay in the market. Do what feels good. Get out. There is an inverse relationship between your threshold of pain and success in the markets, so as soon as you feel the pain: get out. What if you have on a long position and prices are going up, does that feel good? Do you know what you’re supposed to do? Keep feeling good; leave it alone. It’s working fine. Stay with positions that make you feel good; get out of positions that make you feel bad. You’ll know when you feel bad; if you can recognize anything. you will recognize “this-doesn’t-feel-good.” The minute it doesn’t feel good, stop doing it. It’s that simple.
Postscript
In the Preface, we saw that Henry Ford personalized his successes and lost nearly a billion dollars by following his opinions to the bitter end. But Henry Ford wasn’t the only businessperson who personalized his successes and then suffered a huge loss.
Sir Freddie Laker, the British entrepreneur, started a no-frills trans-Atlantic airline service, Skytrain, in 1977. Laker’s story is the classic one of a factory tea-boy who, through hard work and effort, turned himself into a jet-setting millionaire. In order to achieve fortune and fame, he had taken on both the U.S. and British Governments and the International Air Transport Association, the international airline cartel. Granted, the service was only across the North Atlantic, but it would spread to all routes — wouldn’t it? All this warrior had to do was to take on those representatives of the establishment a few more times.
A combination of factors, including adverse currency movements and the U.S. government grounding of all DC-10 airplanes in 1979 right at the start of the peak holiday traffic season, began to strain Laker’s financial situation. As the storm clouds gathered around Laker Airways, Laker dismissed the idea that he was under severe financial strain: “No, I am not bust!” (Sound like denial to you?) He maintained this position even after it became obvious that the airline would not be able to meet the $48 million repayment of interest and principal needed between September 1981 and March 1982. Offensively, Laker told the bankers that he was going to teach them their jobs. “I have innovated in aviation; now I must innovate in banking,” he boasted. (Sound like emotionalism, i.e., the prestige in a crowd decision?) Right up until the last minute, Sir Freddie Laker maintained that all was going to turn out satisfactorily; his airline was not going to go broke. But it wasn’t to be. On Thursday, February 4th, 1982, at 8 a.m. the receivers were called in.66
Also consider the case of personal computer pioneer and whiz-kid, Steve Jobs. With no formal training in computing, Jobs divined the shape of things to come. His once unconventional ideas, which foresaw the personal computer revolution, proved prescient. After creating Apple II, the first wildly successful and popular personal computer, Jobs led and inspired the team that created the most acclaimed PC, the Macintosh. His “faith in his own genius,” as The Wall Street Journal called it, which served him well at Apple helped precipitate his fall from a very lofty perch when he started his subsequent computer company, NeXT. He ignored advisor’s repeated warnings about flaws in NeXT’s strategy and stuck tenaciously to his vision. This time, however, Jobs’s vision proved flawed. NeXT has never turned a net profit and has exhausted $250 million from backers.67
As a final example, look at the story of Roy Raymond who started the highly successful chain of seductive and elegant lingerie stores, Victoria’s Secret. In 1982, he sold the business to The Limited for $2 million. Says a friend of Mr. Raymond’s, “Roy had that feeling that he was bulletproof and that whatever he touched would turn to gold.”68 His next endeavor was an upscale children’s clothing store which plunged him into bankruptcy proceedings.
Each of these men personalized his successes, and began to believe he would only ever have success. On the other hand, consider Roberto Goizueta, CEO of Coca-Cola. When Goizueta became president. in 1981, he created a Strategy for the 1980s, which spelled out his intention to “diversify Coca-Cola into services that complement our product lines and that are compatible with our consumer image.”69 Few people, including the media, took him seriously. Then in 1983 Coke purchased Columbia Pictures. People were aghast. “Financial analysts dumped on the deal claiming Coke had paid too much, and besides — what did Coke know about making movies?”70 Coke’s stock dropped ten percent within a few days. During the rest of that year, however, critics had to admit that Coke (and Goizueta) hadn’t been so dumb after all. Columbia cranked out three smash hits in a row: Tootsie, Gandhi and The Toy. Goizueta also introduced the idea of lending the magical Coke name to another soft drink, an idea most people at the Company viewed as heretical. In fact, when a few daring men suggested the same idea in the early 1960s while developing TaB, then CEO J. Paul Austin condemned them for it. Two decades later here was Austin’s replacement proposing to lend the Coke name to a diet soft drink. Diet Coke was an instant phenomenon, surpassing all Company expectations.
“By the end of 1983, Goizueta felt vindicated in the eyes of the world. Columbia, a money machine, earned $91 million in its first full year as a Coca-Cola subsidiary. In 1983, following hard on the heels of diet Coke’s unparalleled achievement, the company introduced caffeine-free versions of Coca-Cola, diet Coke and TaB. Goizueta proved that Coke could adapt, and once the giant stirred, it usually dominated a market segment.”71 Goizueta’s triumph intensified, dominating a 1983 spring issue of Business Week, being named by AdWeek “marketer of the year” and being praised by Dun’s Business Month for running one of America’s five best-managed companies.72 It would seem that Roberto Goizueta had every reason for self-congratulation. Yet in 1983 he said, “There is a danger when a company is doing as well as we are. And that is, to think that we can do no wrong: we can do wrong and we can do wrong big.”73
In 1985, Goizueta decided to change Coke’s secret formula. He had been a chemist at Coke for many years and the idea of changing the formula had been around for a long time. He announced the change to New Coke at a press conference on April 19, 1985. Goizueta called it the ‘‘boldest single marketing move in the history of the packaged consumer goods business,” and that it was also the “surest move ever made.”74 There was immediate disapproval from the media and public. Business Week called the decision the marketing blunder of the decade and many others agreed. But “the ready, fire! aim philosophy had worked so far, and this audacious, bold move would prove Coca-Cola’s leadership to any doubters.”75
Is it possible Goizueta had personalized his previous successes? Was he experiencing the Midas touch syndrome? He had made several major decisions with which others disagreed, yet each time he had been proven right. Unlike Ford, Laker, Jobs and Raymond, Goizueta didn’t personalize his previous successes, so he was able to recognize and accept the “loss.” He didn’t make the matter an issue of personal p
ride and choose to fight to the bitter end. He recognized it as a losing proposition to eliminate the original formula altogether. He cut his losses and moved on. He managed the situation brilliantly by re-introducing the original formula under the name Coca-Cola Classic and increased Coca-Cola’s market share in the soft drink business in the process.
Why was Goizueta able to avoid entering the trap that produces the fatal errors? Was it because managers are exempt from this pitfall? No. We’ll see shortly that managers are quite susceptible. Did Ford, Raymond and the others succumb because they were entrepreneurs, and entrepreneurs have difficulty going on to be managers? No. There are numerous cases of the founding entrepreneur going on to successfully manage the company, for example: Fred Smith at Federal Express, William McGowan at MCI Communications, Bill Gates at Microsoft. So what was it that separated Goizueta the others? They fell into a category aptly described by William Sahlman, Professor of Business Administration, Harvard Business School this way: “I’ve seen people who have been at a certain place at a certain point in time with a good idea . . . and did [sic] fabulously well, and they haven’t a clue about what to do next. They’re not good advisors and they’re not repeat entrepreneurs. And there’s a process of assuming, based on what you’ve succeeded in doing in the past, that you’re a genius.”76 The process Sahlman is referring to is the process of personalizing successes as explained in this book. Goizueta avoided the process and the others didn’t. He didn’t equate his personal worth with whether or not his idea was successful. He distinguished external successes and losses from internal ones, and he didn’t personalize his previous accomplishments. He knew the difference between being right and doing right, and he avoided emotionalism. That’s what sets the successful decision-maker apart from the not-so-successful.
Even though Goizueta was primarily a manager and the others were primarily entrepreneurs, they were all in the business of making decisions, the goal of which is the profits of managing risk, not the ego gratification of being right. Remember, you don’t get any money just because you know why the market is going up or down. You only get money if your plan has positioned you to capitalize on the market’s movement, regardless of whether or not you know why the market is up or down on a particular day.
Harvard Business Review, the bible of management theory, says “An essential quality needed by a good salesman is a particular kind of ego drive which makes him want to make the sale in a personal or ego way, not merely for the money to be gained. His self-picture improves dramatically by virtue of making the sale and diminishes with failure.”77 It is precisely this quality which is so detrimental to a Speculator and any other type of decision-maker. Realizing this helped me understand why I was able to make so much money as a salesman yet couldn’t make a dime as a trader. Remember my futile efforts to make all the money back and the realization I had about having never been a trader? I had been a good salesman and at the right place at the right time, not a trader.
This doesn’t mean salespeople can’t be traders, and it doesn’t mean salespeople can’t be managers or entrepreneurs. But it does mean given a salesperson’s (i.e., a broker’s) motivation, he needs to have a plan that will prevent the market position or his client’s position from becoming personalized the way I personalized my clients’ losses after I blew up the Cleveland office. The ego drive of a salesperson may also explain why salespeople have a reputation for being lousy traders. How so? A salesperson’s goal is to make the sale; to be right by countering objections and negative feedback from the prospect. But the Speculator’s goal is to make money; not to be right or counter the negative feedback from the market. A salesman’s ego gratification from being right is precisely what the entrepreneur, Speculator and manager must avoid. Tying one’s self-picture to the success or failure of the business venture or market position means the individual will not want to acknowledge a loss when it occurs and will play out the pattern outlined in the flow chart. This is true for all losses resulting from psychological factors, regardless of the scale of the loss in dollar terms ($1,000 or $1,000,000) or the venue in which the loss takes place (in the markets or in other lines of business). For instance, a 1989 study in the Journal of Accounting Research78 concluded that managers are “reluctant to give up on projects they begin because to do so would convey a negative signal about their ability.” Moreover, a “manager might not choose to sell the assets because the potential sale would convey negative information about him personally.” The study also found that when such a manager was replaced, his “replacement who does not care about the first manager’s reputation, would have no such reason for holding onto the assets, and will tend to sell them relatively quickly.” The replacement manager was able to be objective; his predecessor wasn’t. What does this tell you? Managers and corporate executives can become too attached to a project and personalize it, and they are susceptible to the losses due to psychological factors just like Speculators are when they personalize market positions.
What you have to understand as a Speculator, entrepreneur or manager is that there is a fine line between perseverance because you think the idea is a good one, and perseverance because you think the idea is a good one. The former is objective. The latter is subjective and often follows personalizing previous successes. In the first case, you arrived at the decision deductively after examining the evidence. The decision is supported by the facts and you have a pragmatic exit discipline — a defined set of circumstances which will cause you to determine the idea is no longer a good one, because the evidence no longer supports the original decision. In the second case, the decision is made first; with no exit strategy, you inductively seek evidence which will support the decision. In the former, your thinking is used to explore possibilities and you arrive at a conclusion by default; in the latter, your thinking is used to defend a previously expressed opinion and to protect your ego, which is attached to that opinion.
If you didn’t understand the distinction about perseverance mentioned above, you might think all you had to do to be a successful entrepreneur was believe in your idea and take on the risk of carrying it out. After all, that’s what entrepreneurs do, right? They take risks. Some of them take seemingly huge risks; so huge that entrepreneurs are often compared to daredevils. But are they actually seeking risks?
Look at Scott Schmidt, the “entrepreneur” who popularized what has become known as extreme skiing. Schmidt jumps from 60-foot cliffs for a living. Ski-equipment companies sponsor him, and people make videos of his jumps. From the chairlift, he appears a reckless maniac. But for every jump, he has carefully charted the takeoff point and landing. . . . His pioneering work has broken a path for an “industry” of extreme skiers — some of whom have been more reckless and died. Schmidt doesn’t consider himself reckless.79
Given his approach, Schmidt isn’t reckless — he charts (i.e., plans) his entry and exit to the jump. He doesn’t seek risk; he seeks to reduce and manage risk.
Look at self-made billionaire entrepreneur Craig McCaw. Despite any appearances to the contrary, Craig McCaw, founder and Chairman of McCaw Cellular Communications, maintains that he and those at his company “have always been risk averse.”80 And how did his approach to the business develop? From a game. (Sound familiar?) During early business trips and chess games with J. Elroy McCaw, his father, who was also an entrepreneur, Craig “learned the concept of an exit strategy.” (Emphasis added.) “Every deal we ever did had a back door. The public just didn’t see the back doors.”81 This is just another example of what this book has been saying about the need for a stop-loss (i.e., exit strategy) and of the benefits of applying the positive attributes of a game to the continuous process of business and the markets.
What’s true about the markets is also true for business in general. Just as there are many ways to make money in the markets, there are many ways to make money in business. Sam Walton made his money one way, and Gucci made his another way. You can read through the annals of Amer
ican business and see extraordinary variety in the personalities and methods among the best known entrepreneurs and business people; they come in all shapes and sizes. Some were team efforts, others were individual. Some had a lot of money to get started, others did not. The differences go on and on. There is no single pattern to how the most successful entrepreneurs or the best managers in business make money. However, there is a common denominator among this group: rather than just taking risks, as is commonly assumed, they excel at judging, minimizing and controlling risks. Craig McCaw understood this; did Steve Jobs? Over a period of eight years NeXT has “consumed $250 million without producing a successful product or sustained profitability.”82 What is the exit point? The original capital infusion from Ross Perot and Cannon, Inc. was $125 million. Was it known then that the loss might go to $250 million? If so, fine. But if not, what’s to keep it from going to $350 million? Managers of all businesses must be able to take losses.
Alan “Ace” Greenburg, CEO of Bear Stearns says, “The definition of a trader is a guy who takes losses.”83 This is exactly the point made earlier about losses being a normal part of business, and how trying to avoid losses altogether by not taking them is a loser’s curse. Bear Stearns has weekly “cold sweat” meetings in which traders are grilled about their positions. The firm tolerates losses but not surprises. In one such meeting, a trader was asked about one of his positions and what the downside was. He outlined several scenarios and the losses associated with each. When the position started to deteriorate, the firm took the mounting losses, upwards of $10 million, in stride. They were prepared for such an event. The losses never surpassed their stop-loss point and the position soon turned around and made money. It is important to understand that they held on not because they wanted to look good, look smart or be right. They held on because the position remained within previously defined and acceptable loss parameters. Remember, people participate in the markets — all markets — either to satisfy a need (i.e., solve a problem) or to satisfy a want (i.e., make them feel good). Managing risk solves a problem and should never be engaged in to feel good, look smart, or be right.
