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Summary

These stories of traders losing hundreds of millions or even billions of dollars are quite dramatic. Many reports and articles about these events blamed the spectacular losses on the lack of accounting controls. Specifically, they blamed the failure to separate the operations function from the record-keeping function. I would agree that this problem allowed the losses to get larger and larger. These traders continually broke the rules of their companies and some of them even broke the law. Nevertheless, the root of the problem was not the lack of accounting controls, but the human reaction to taking a loss. The lack of accounting controls was just the enabler. The source of the problem was caused by the same psychological biases that affect all investors.

Specifically, the loss of some money induced the traders to take riskier positions. Chapter 2 describes this as a desire to break even that manifests itself in a “double or nothing” attitude. That is, investors frequently take risks to get back to even, risks that they would not have taken before the loss. In other words, they throw good money after bad. This trap can have a devastating effect on your wealth.


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