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women, and it has the provocative title of “Boys will be boys.”12
In what way were boys being boys in this study? Professors Barber
and Odean found that men in this study were worse investors than
women. Per each dollar invested, men earned significantly less money
than women. In investigating the reasons for the gender difference, it
turned out that men traded 45% more frequently than women.
Every trade is costly so all other things being equal, the more an
investor trades, the less money at the end of the year. All that extra trad-
ing definitely cost men. How about the actual stock selection? Were men
or women better at picking winning stocks?
Professors Odean and Barber found that men and women are equally
bad at picking stocks. On average, every trade cost the investors money
as compared with not trading. Men did worse simply because they
traded more. The study concludes, “Men lower their returns more than
246 Profiting from the New Science of Irrationality

women because they trade more, not because their security selection is

Conclusion: Never trade emotionally, and trade as little as possible. If
you can trade like Paul Tudor Jones II or fly a jet like Maverick, then you
don™t need any advice.

Lesson #2: Never Trust Anyone,
Not Even Yourself

During the technology bubble of the late 1990s, one of the best ways to
make money was to get some stock at the initial public offering (IPO) of
a company. The most famous of these IPOs was that of theglobe.com
whose stock went up by more than 600% on the first day.
Of theglobe.com™s stock at the offering price, $10,000 netted a profit
of $60,000 in a matter of hours. Sure beats the day job! Dozens of other
IPOs had enormous first-day rises.
How do we get our hands on some of that IPO stock? In Glengarry
Glen Ross a group of real estate salespeople ask a similar question. In a
tough environment where sales are lagging, Alec Baldwin is brought in
to motivate the team.
Baldwin arranges a contest: Whoever sells the most in the next week
will earn access to the coveted (and closely guarded) “Glengarry Glen
Ross leads.” These contain the names and contact information for people
who are very likely to become buyers. With the promise of easy money,
the salespeople do everything they can (legal and illegal) to get their
hands on those golden leads.
In the bubble, people did all sorts of things to get into IPO stocks. I
was never invited to participate in any of this, and I watched others with
envy. On the day of the Etoys™ IPO, for example, my friend Judith told me
about an acquaintance who had made $20,000 “trading” the stock. When
Timeless Advice 247

I inquired further, I learned that this brilliant trade was caused by the
grant of some of the IPO stock through a contact in the company. In the
bubbly IPO environment of the time, this was simply a gift, not a trading
In late April 2000, my phone rang. It was Andy, my broker, offering
me a chance to get in on an IPO. Was this Glengarry Glen Ross chance
going to make me money? Hardly. The stock Andy was offering was in
AT&T wireless, which trades under the stock symbol AWE. I could buy
the stock at the IPO price of $29.50 per share. I did not buy.
Part of the reason that I did not buy was because of a story in the great
investing book Reminiscences of a Stock Operator.13 The book is filled
with the trading exploits of a character based on the famous speculator
Jesse Livermore. In one escapade, our hero receives a stock tip, listens
carefully, and then makes money by doing exactly the opposite.
I thought of this story when Andy called with his AWE stock. Why
was he calling me for this IPO when he had never called for any other
stock offerings? I could think of many reasons for this unique offer, but
none of them suggested that I would make money from buying this IPO.
In fact, if I™d been a top gun trader, I would have bet against the stock by
selling it short. Being a bit more cautious, however, I simply declined the
offer to buy, and watched the stock carefully.
What happened to my only chance to play in the IPO game? The stock
essentially went straight down. After a very brief and small rise above the
offering price, the stock sank to under $5. (By the end of movie, the
Glengarry Glen Ross leads are revealed to be worthless; so in some sense
my opportunity did mirror that of the salespeople in the movie.)
One lesson from this experience is to not take tips from anyone. Inter-
estingly, this extends to even taking tips from ourselves. How is it even
possible to give ourselves a tip? And why should we be skeptical of our
own tips?
Recall that it is useful to think of the brain not as one cohesive entity,
but rather as a society of mind (to use MIT professor Marvin Minsky™s
phrase) having different, and sometimes competing goals. The more
248 Profiting from the New Science of Irrationality

thoughtful, cognitive parts reside in the prefrontal cortex, while the lizard
brain lives elsewhere. Recall also that recent studies in neuroscience
implicate the lizard brain in some of the behaviors that tend to cost us
When we get an urge to make a trade, it may be the lizard brain pro-
viding us with a tip. While the lizard brain may have led our ancestors to
big game, it is not likely to make us rich. So when we get a hot tip from
ourselves in the form of a trading idea, we should treat it with suspicion.
Is the idea based on good, unemotional analysis? Or does it arise magi-
cally from an unknown place?
Here™s one clue that I have found useful to discovering the source. If I
feel that there is a pressing need to trade now”that this is a fleeting and
golden chance”then I suspect the lizard brain is at work. In all cases
(whether the urge is strong or not), I wait at least one week between a
trading idea and its implementation. Occasionally, this rule will cause me
to miss a great trade, but it also prevents me from making a lot of bad

Conclusion: Never trade on other people™s tips. Treat your own ideas for
trades with some skepticism. Never trade impulsively, as you might be
falling for a bad tip from the lizard brain. Always include a significant
delay between an investment idea and an actual trade.

Lesson #3: Losers Average Losers

In Chapter 2 we discussed one of the two handwritten signs that I saw
over Paul Tudor Jones II™s desk in 1987. The second note said, “Losers
average losers.”
What does this mean? Let™s analyze it in three steps. First, what is
averaging? Second, what does it mean to average a loser? Third, why is
it that losers average losers?
Timeless Advice 249

Averaging an investment means adding to an existing position. For
example, I started buying Microsoft stock in the early 1990s. Taking into
account all the stock splits, the price I paid was about $2/share. Over the
next few years, I bought more of the stock at progressively higher prices (it
eventually topped out at $60). As I bought more, the average price that I had
paid for my Microsoft stock changed. In particular, my average price rose as
I combined more expensive stock with the original buy at $2. Increasing the
size of an existing investment is averaging.
Averaging losers is buying more of an investment that has gone down
since the original purchase. If the price of Microsoft had dropped, and I
had bought more at a lower price, then I would have been averaging my
purchases on one of the “losers” in my portfolio.
“Losers average losers” means it is the bad investors (i.e., the losers)
who buy more as an investment declines. Paul™s note essentially means
that adding to a losing investment is throwing good money after bad. This
“losers average losers” is one of the most famous lessons in all trading.
In fact, it is the number one lesson cited in Reminiscences of a Stock

I did precisely the wrong thing. The cotton showed me a loss and I
kept it. The wheat showed me a profit and I sold it out. Of all the
speculative blunders there are few greater than trying to average a
losing game. Always sell what shows you a loss and keep what
shows you a profit.

The idea that losers average losers is not news (Reminiscences was first
published in 1923). What is new is the link to the science of irrationality.
Professor Kahneman has documented the irrational manner in which
human psychology handles losses. As we saw in Chapter 2, our behavior
becomes even more irrational when we are confronted with taking a loss.
We become emotional risk takers, willing to bet the house in order to sal-
vage our pride. This instinctual desire to avoid losses, paradoxically,
tends to create even more losses.
250 Profiting from the New Science of Irrationality

Even experienced traders must fight the tendency to average losers. I
recall a related incident when I was working at Goldman, Sachs & Co.
The boss of the corporate bond area was visiting each trader to review
buy and sell decisions. The partner became enraged when looking at one
trader™s list of buys and sells, and threw it in the garbage (nowadays this
is all done on computer, but in 1987 there were paper copies). The part-
ner said, “You™ve sold all your winners, and you™ve kept all of your
losers. I want you to sell every one of these dogs before the day is over,
or don™t come in tomorrow.”
Even great and experienced traders must fight the impulse to hang
onto and average into losers. The Goldman, Sachs & Co. trader guilty of
this cardinal sin was a veteran with about eight years™ experience and was
probably making more than a million dollars a year. In fact, the “losers
average losers” sign above Paul Tudor Jones™s desk suggests that even he
felt the need for a reminder to avoid this mistake.

Conclusion: Never average losers. Buy more of an investment only when
(and if) it increases in value.

Lesson #4: Do Not Dollar Cost Average

So losers average losers. Those who agree with this statement should not
invest by “dollar-cost averaging.” What is dollar-cost averaging, and why
is it a form of averaging losers?
Here™s how an article on the Motley Fool website describes dollar-cost

Dollar-cost averaging can be a good way to protect yourself from a
volatile market. It™s the practice of accumulating shares in a stock
over time by investing a certain dollar amount regularly, through up
Timeless Advice 251

and down periods . . . The beauty of this system is that when the
stock slumps you™re buying more, and when it™s pricier you™re buy-
ing less.

The conventional wisdom suggests that dollar-cost averaging is a great
way to invest. It often takes the form of a payroll withdrawal that is
invested into stocks. Such payroll purchases are a form of dollar-cost
averaging because the same numbers of dollars are invested in each
Sound reasonable? In fact, dollar-cost averaging is a profitable strat-
egy as long as the money is invested into something that goes up in price
persistently. In bull markets, every drop in price is an opportunity, and as
the Motley Fool suggests, the “beauty” is that the investor scoops up
more shares during “pullbacks.”
While dollar-cost averaging works in bull markets, it is not profitable
in long-term declines. Imagine, for example, what would have happened
to an investor whose dollar-cost averaged into Etoys stock. Each month,
as the stock price of Etoys fell, the investor would be buying more shares
for the same dollar amount.
As the Motley Fool piece suggests, it is true that “when the stock
slumps you™re buying more.” That™s great except for the fact that Etoys
filed for bankruptcy; at which point the shares became worth zero.
Dollar-cost averaging doesn™t work well for declining investments.
The Japanese Nikkei peaked over 40,000 in 1989, and 15 years later it
sits at around 12,000. So an investor who “yen-cost averaged” into Japa-
nese stocks over the last 15 years would have been averaging losers; that
is, owning more and more of a declining investment.
Even if you are optimistic that Japanese stocks will rise from current
levels, you would be better off buying now. You could buy today at a
much lower price than you would have paid by averaging, and you could
have avoided 15 depressing, losing years.
Averaging into a declining market is a form of throwing good money
252 Profiting from the New Science of Irrationality

after bad. If this is true, why is dollar-cost averaging so popular? The
answer is that a lizard brain that has lived its entire life in a bull market
loves dollar-cost averaging. In fact, the backward-looking lizard brain
loves whatever has worked in the past.
In the United States, dollar-cost averaging into stocks has always paid
off in the “long-run.” That is because throughout history U.S. stocks have
always eventually recovered and gone on to new highs. In what has been
a 200-year bull market in U.S. stocks, marked by some extreme pull-
backs, dollar-cost averaging has worked well. It will not be profitable,
however, if stocks enter a persistent decline. Price declines in secular
bear markets are not pullbacks, they are just setbacks on the way to more
Dollar-cost averaging is a bull market strategy. It is the equivalent of
being loaded for squirrel. As long as there are no vicious bears, then
being loaded for squirrel is perfect. Thus, dollar-cost averaging into U.S.
stocks is a form of investing by looking in the rearview mirror. It has been
a great strategy throughout U.S. history, but that does not mean that it
will be a profitable strategy in the future.

Conclusion: Do not dollar-cost average. Unless you have some secret
knowledge that we are not in a bear market, dollar-cost averaging can be
a form of averaging losers. Remember: Losers average losers.


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