Thursday, October 25, 2007

How to lose a million and be smarter for it

What I Learned Losing a Million Dollars should have more recognition (not to mention distribution) because what it has to say is excellent. It tells the story of Jim Paul, a trader "from hunger" who rode some combination of luck, timing and hubris all the way to the Executive Board of the Chicago Mercantile Exchange. Then he gets a wild hare that bean oil futures are going to skyrocket, and when they do, he doesn't get out. He stays convinced that they're going to the moon... and they don't. $1,200,000 later, he loses his seat on the Exchange and discovers that he had never been a trader after all. Really just lucky.

But why did he stay in? He proceeds to take the psychology of market loss on a trip around that mountain. After a market loss, most people study a different way to find profit in the market, in order to make the money back. And Paul did that for a while, but discovered that all the great traders contradicted themselves on what worked. Where they agreed was that one should not lose money. "There are as many ways to make money in the markets," says Paul, "as there are participants. But only two ways to lose it."

Losses, Paul explains, occur either due to a failure of analysis or failure to execute on the analysis. Most analytical methods allow for some loss, which is expected, but catastrophic loss is typically due to a failure of execution. So, how do you not fail to execute?

First, you must understand your motive for participating in the market. Is it a "profit motive" or a "prophet motive"? Do you want to be right or be rich? Because if you want to be right, a continuous process like business markets is probably not for you. You should play poker. If you want to be rich, you should be careful not to confuse the two, and proceed to make some further distinctions: what is your stop-loss point, why are you entering, and what is your goal, in that order.

Applying this metric allows you to take the beneficial properties of games, that of discrete bets or gambles, and apply them to markets. You're "chunking" your risk exposure into discrete blocks that you are aware of before you enter the market. Then your market play becomes a simple if-then series.

I mention all this because I'm watching my father struggle after 8 months floundering in the job market, and his words echo that of Paul losing his bean-oil futures. "It'll turn around! I'll certainly have a job by April." Well, what if you don't? What's your stop-loss point? When are you going to exit this obviously failing market? Hiring, like any market, is a continuous process, and to forever expose yourself to the risk of your share in it plummeting is a fool's game.

The lesson applies equally well to businesses. We've changed our profit strategy several times here at Treemo because we're not so foolish as to think being "right" will create a sustainable company. Mobile media sharing has a lot of possibility, and sticking to one of them in the face of obvious failure is a great way to burn a lot of investor money. We're happy with the stance we're taking right now, and it's getting a great response in the market. It took plenty of experimentation to get there.

But more than that, we've got controls. The business plans have direction changes in them for when business dries up in any area. There's plenty of stop-loss, so I sleep well at night knowing that long before the bank account gets thin, we've got a plan. And so should you. What are the markets you invest in?

Most of us have a job market in which our investment is our time and training. We also have networking markets that we play, knowledge markets, even habits. What are the areas that you've internalized external markets that fail you? Do you, like my father, see a dry job market as a reflection of your self-worth? Is that going to cause you to hold to a failing strategy just to prove yourself right? Or will you have the prescience to exit because you'd rather be rich?

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