When I had established my own office while trading, I had a large sign put up in three different locations so that all my traders could see it. The sign read:
“MISTAKES COST MONEY.”
Our goal was 100% perfection – avoiding any and all mistakes. But we were human and they happened. Fortunately, the percentage of errors we made were probably less than one hundredth of one percent.
Realizing that even the most meticulous person could make a mistake, I had a very simple rule for remedying it. Once the error was observed, the trade had to be closed immediately, win, lose or draw. I allowed no exceptions to this rule.
This was the second most important rule in trading and I mention it because today Jamie Dimon testified before the Senate Banking Committee about a really, really big mistake – one I could never have come near to committing in my rather minor career. I had nowhere near the capital or resources of J. P. Morgan Chase.
In my view as a trader, I believe that when the mistake was discovered, Chase’s traders did the right thing – that is they “unwound” the trade as quickly as they could without completely destroying the market and making the loss even worse. I give them credit for that.
Perhaps if I have a criticism of this event it is that I believe they may have overlooked the most important and first rule of trading: Never add to a losing position. During a number of years as a trader I must have seen at least several hundred people come and go (usually fairly quickly) because they violated that rule.
Now if you’ve followed me for a short while, you know that I believe common sense and logic are essential if we are to address and resolve most of the challenges we confront. So let me explain this for those of you who are perhaps not familiar with trading and markets.
Whether you are a long-term investor or a trader, it’s pretty much the same thing. You purchase a stock, commodity or security because you believe that it is going to appreciate in value and you will have more money when you sell it than you are investing today.
But you buy your 100 shares of XYZ corporation at $50 per share and it promptly declines to $48. So you decide to invest an additional $4800 in XYZ by buying another 100 shares, lowering your average price to $49. But XYZ continues to go down and is now at $46 so you plunk down another $4600. You have reduced your average cost to $48 a share.
Why have you broken the cardinal rule of trading? Let’s think back to your motive in making the original investment. You thought the stock would go up from your original $50 purchase price. Did it? No. You were wrong in your analysis. And now you have compounded your error not once but twice. Why? Because of your ego. You decided that you were bigger and more important than the market (none of us is) and that for the simple act of your taking the position you did, you were deserving of earning a profit. (No one is).
I apologize if some of my readers got a little bored with the math of this whole thing, but math is what trading is all about. And if I were to offer a criticism of the traders at J. P. Morgan Chase it is that they may have well violated this rule and the trade got out of their control to handle.
I listened to Mr. Dimon’s testimony today. I have to say the guy has guts and is one of the few people roaming planet earth who accepts accountability. We need more leaders like that in this world. He admitted that it happened on his watch and that he accepted blame for allowing it to happen. He promised that as a result of this trade, J. P. Morgan Chase was instituting new and tighter controls. Let me tell you from personal experience, no one in the business of trading likes to take a loss – let alone one for $2 Billion. It is simply good practice and common sense that Mr. Dimon’s firm would be looking internally at ways to avoid a recurrence of this event.
One of the reasons for today’s Senate hearing was to help that august body decide if we need newer and tighter controls over the banking industry. That is why Mr. Dimon was called on the carpet – and I must say, the man was far cooler then I could imagine myself having been if I were in his hot seat.
But in viewing this, I like to put things in perspective.
First, I agree that it is important that we have sensible regulations to control what might turn out to be a financial fiasco. But it is important to recognize that it was not any Federal regulator or regulation which put an end to this abysmal trade. It was Chase which made the discovery and unwound their position. They did the right thing, albeit somewhat too late.
Second, I would like to take the rare opportunity to compliment the members of the Senate hearing. Frankly, I had expected this hearing to have been conducted in more of a “witch hunt” mentality. That was comparatively negligible and many of the Senators asked questions which were both thoughtful and provocative. Some of them actually did their homework. My hat is off to them.
Third, getting back to the question of leadership, the Senate is a body which is refusing to consider any sort of budget and has not allowed one to come forward now for several years. That is their responsibility to you and me and I am embarrassed that the leader of that body represents my state. Senate Majority Leader, Harry Reid shame on you for abdicating your responsibility.
Finally, I would turn to the man who is the head of our ship of state, President Obama. During his administration, we have seen an increase of over $5 Trillion dollars in our acknowledged national debt. That is 2,500 times the size of the loss that Chase endured (and paid for out of earnings), all of which he lays at the feet of his predecessor.
I sincerely hope that the President tuned in for today’s Senate hearing. It might prove to be an important lesson for him.
I call it “Leadership 101.”