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 success.

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 Id 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. Interestingly, 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 Minskys phrase) having different, and sometimes competing goals. The more

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 money.

When we get an urge to make a trade, it may be the lizard brain providing 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 magically from an unknown place?

Heres 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 decisions.

Conclusion: Never trade on other peoples 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 IIs desk in 1987. The second note said, Losers average losers.

What does this mean? Lets 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?

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. Pauls 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 Operator:

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 salvage our pride. This instinctual desire to avoid losses, paradoxically, tends to create even more losses.