Watch Your Loses and Your Profits

Will Take Care Of Themselves

"What I learned losing a Million Dollars."

That's the unique title of a book published by Jim Paul, who was a vice president in charge of Dean Witter Reynolds International Energy unit in New York.

The book is a bit of a biography, a confession and a drama. But, to any aspiring investors, who wants to improve their performance, it's a good lesson in how to avoid getting trapped and crush by the market's volatile movements the way Paul did.

Our story picks up with Paul rising through his career to be a trader and finally a member of the Chicago Mercantile Exchange's board of Governors and Executive Committee in the early 1980s.

He had been trading lumber, but when that market dried up he switched to soybean oil. In early 1983, he started building bull spread positions in soybean oil.

Paul was bullish. His strategy was to go long the nearby month and short a deferred month. If there was a shortage and supplies got tight, the nearby month's price would go up faster than the deferred month and he would make money.

In August 1983, the U.S. Agricultural department made a report indicating damage to the soybean crop. The news should have sent soybean prices higher profiting Paul. But, instead they went limit down for a few days.

As Paul relates in retrospect: "The oldest rule in trading is if a market is hit with bullish news and goes down sharply instead of up something is wrong."

However, Paul held believing he was right and the market was wrong. By September, the tide turned in his favor and his bean trade started to click. In one day alone, he made $248,000 on his position. His thoughts: "I am going to get rich." He went looking for a $400,000 motorhome and bought a Porsche 911 convertible.

Then the soybean trade gradually began to turn against him. The decline was relentless. His friends bailed out. Paul didn't. He began to rationalize. His friends lacked courage to hold their position. He was in for the long pull. This was going to be his big trade.

As Paul's trade got worse he kept saying to himself: "It's going to turn tomorrow. It didn't. He borrowed money to meet margin calls but that ran out. Finally, his position was "mercifully" liquidated by the brokerage firm. Net loss: $1.2 million - a wipeout.

After suffering the emotional and personal humiliation of losing his money, Paul set out to find out how the great ones made their money trading.

He became bewildered at first.

Jim Rogers: "I haven't met a rich technician

Marty Schwartz: "That's nonsense. I got rich as a technician.

John Templeton: "Diversify you investments."

William O'Neil: "Diversification is a hedge for ignorance."

Peter Lynch: "You have to understand a business so you know when to buy more of the stock when it goes down."

William O'Neil: Averaging down is an amateur strategy that can produce serious losses.

Then Paul realized there is no "Holy Grail" to making money in the markets.

Then, he studied what the successful investors said about losses and it all came together.

Marty Schwartz: "The most important thing in making money is not letting your losses get out of hand. I am more concerned about controlling the downside."

Paul Tudor Jones: "I am always thinking about losing money as opposed to making money. Don't focus on making money; focus on protecting what you have.

Warren Buffett: "The two rules of investing are try never to lose money and the second is never forget rule one."

William O'Neil: "Most unskilled investors stubbornly hold their losses. They could get out cheap but being emotionally involved they keep waiting and hoping until their loss gets big and cost them dearly."

Bernard Baruch: "Learn to take losses quickly and cleanly. Don't expect to be right all the time. If you make a mistake, cut your loss quickly."

The moral of Paul's story is there is more than one way to make money in the markets - and those that have done it have used a variety of approaches some even contradictory.

The key is to learn how not to lose big money. There will be losses - and that's part of investing - learning to take them when they are small is what's important.


Copyright Ticker Tape Digest August 23, 1996