MarketFox Investment Commentary – Investment Innovation Institute

MarketFox Investment Commentary

In Search of Temperament IV

Self-Awareness and Self-Control

This is the fourth part in a series on the ideal investor temperament. So far, we’ve examined curiosity and flexibility, contrarianism and patience. In this post, we’ll consider Self-Awareness and Self Control. Jim Paul’s life story and the lessons that he learned will be our guide.

I recently finished reading What I Learned Losing a Million Dollars by Jim Paul and Brendan Moynihan. Definitely one of the best books on investing that I’ve read in a long time. It’s the kind of book that every investor should re-read as it’s full of reminders that can help to safeguard our thinking.

The book is divided into three parts. The first part is a brief summary of Paul’s career. He tells the story of how he made it as a successful pit trader and board member of the Chicago Mercantile Exchange. Paul also describes the events leading up to his losing everything, including money he had borrowed from friends and family, in less than three months.

As Paul explains, his problems all started when he had his best day of trading ever – a $248,000 profit on a single trade. The second part of the book presents the lessons that Paul learned from the experience. Paul outlines a framework for managing investor psychology in the third and final part.


There are lots of ways to make money in the market. And much of the advice on making money is contradictory. Paul’s experiences taught him that it’s far better to study why investors lose money. All losses have two causes.

Losing money in the markets is the result of either: 1) some fault in the analysis or 2) some fault in its application. As the pros have demonstrated, there is no single sure-fire analytical way to make money in the markets. Therefore, studying the various analytical methods in search of the ‘best one’ is a waste of time. Instead what should be studied are the factors involved in applying, or failing to apply, any analytical method.

What causes an investor to stop thinking analytically? Internalising profits and losses, Paul explains:

The very use of the term 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 personalised; and 3) any losses (or successes) are going to be internalised.  

Personalising profits and losses switches an investor’s mindset from a ‘profit’ motive to a ‘prophet’ motive. This is why self-awareness is critical. Successful investors are good at monitoring their thinking for signs that they may no longer be acting dispassionately. Paul learned this lesson the hard way.

For example, Paul describes how he went through the Five Stages of Internal Loss:

  1. 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.”
  2. Anger – “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 – “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.”
  4. Depression – “I was so consumed with the bean-oil position that I couldn’t sleep through the night, lost fifteen pounds in four weeks, and lost interest in all the things that I once found enjoyable.
  5. Acceptance – “Without force (i.e. Paul’s broker closing out the position) I never would have accepted, nor taken, the loss.”

Investors can easily loop through and repeat the stages, just as Paul did with each bear market rally.

Paul could have avoided or shortened the Five Stages of Internal Loss if he had a plan in place to deal with his emotions, i.e. self-control. We’ll return to this idea later in the post.

Hope and Fear

Hope[1] and fear accompany every investment decision. Paradoxically, they are two sides of the same coin. For example.

When you’re long and the market is going up, you

  1. hope it will keep going but
  2. fear it won’t

When you’re long and the market goes down, you

  1. hope that it will turn around but
  2. fear it won’t

You get the idea. Multiple conflicting emotions are inextricably linked to every investment decision. Rather than monitor our thinking for signs of every emotion, Paul suggests that we be on guard for ‘emotionalism’.

Emotions are neither good nor bad: they simply are. They cannot be avoided. But emotionalism (i.e. decision-making based on emotions) is bad, can be controlled and should be avoided.

The most emotional and therefore least rational decision-making body is the crowd. Investors can monitor their thinking by being on the look-out for signs of crowd psychology.

Crowd Psychology

Crowd psychology is the arch-nemesis of self-awareness. Paul explains.

A person in a crowd also allows himself to be induced to commit acts contrary to his most obvious interests. One of the most incomprehensible features of a crowd is the tenacity with which the members adhere to erroneous assumptions despite mounting evidence that challenge them. So when an individual adheres to a market position despite the mounting losses, he is a crowd.

This is a key point. An investor doesn’t have to be part of a crowd to display crowd psychology. They just need to display the tell-tale signs of irrationality:

  • A sentiment of invincible power
  • Contagion
  • Suggestibility

In summary, an investor is self-aware if they can tell when they’re acting out of emotionalism. That is, when they have personalised an investment and are now more concerned with being right rather than making money. Of course, nobody is perfectly self-aware. That’s why the best investors also have self-control.


Successful investors understand that the time to exercise self-control is before making an investment, not while deciding or after investing. For example, the time to exercise self-control isn’t when we’re standing in front of an open pantry door staring at the cookie jar. It’s when we’re pushing a trolley through the isles of our local supermarket.

This means having a plan in writing. Planning requires that we think before we act, which is the exact opposite of being led by our emotions.

Creating a plan involves:

  • Selecting a method of analysis
  • Developing rules
  • Establishing controls
  • Formulating a plan


As Paul notes, there are lots of different ways to make money. Successful investors use methods that work on average, over time – not on every occasion. No method is foolproof. That’s why the strategy chosen isn’t the most important factor for success. So, each investor is free to choose a method that suits them. Most importantly, they must have the self-control to stick to it.  That’s easier to do if there’s a good fit between the investor and their chosen strategy.

Rules help to translate your analysis into something that can be implemented. As Paul explains, rules are your answer to the question of “what constitutes an opportunity for you?” It’s okay to refine your rules as you learn through trial-and-error.

Controls are specific exit criteria that will take you out of an investment either at a profit or a loss. Most institutional investors refer to these rules as their ‘sell discipline’. Based on my experience of researching fund managers for over 10 years: most managers pay lip service to their sell disciple and include it in the back of their presentations as an afterthought.

In summary, successful investors don’t ask too much of themselves. They understand that despite their attempts to cultivate self-awareness, they won’t always be able to catch themselves in the act of thinking emotionally. They exercise self-control ahead of time to design a decision-making process – a plan.

Next time we’ll consider the importance of probabilistic thinking and the proper attitude towards making mistakes.

[1] Greed is an extreme form of hope.


[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.