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The Emotions that come from Making $2 Million

Nicolas Darvas was a professional dancer turned stock market speculator. He happened to stumble upon investing when one of his employers opted to pay him in stock instead of cash. As it turns out, Darvas could not make this particular show but in a gesture of professionalism offered to buy the shares from the venue owners. This decision ultimately changed the course of his life and led him to write his well-known book “How I Made $2 Million in the Stock Market.”

Despite the trite title, the experiences shared by Darvas are invaluable to an aspiring trader. Moreover, William O’Neill of Investor’s Business Daily and Market Wizards fame built his proprietary CANSLIM process mirroring most of the Darvas principles.

While still effective and useful today, the principles conveyed in this book are well-known and shared openly online. Instead of touching on those aspects of the book, it will be valuable to examine the emotions experienced by Darvas in his trading journey. In particular, Darvas frequently exhibited classic heuristics that can be explained by Behavioral Finance.

Behavioral Finance is a blend of finance, economics, decision-making, game theory, and psychology that you can use to your advantage as a trader.

Loss Aversion

Several times throughout the book, Darvas displayed loss aversion, or the tendency for investors to take winners too quickly and hold onto losers too long. For instance, Darvas writes that “I was buoyed up and excited by small gains, and overlooked my losses. I completely ignored the fact that I was holding a lot of stock which was standing well below the price I had paid for it and looked like it was staying there.”

Additionally, when Darvas was developing his Box Theory he noted that he needed to “discipline himself to not sell a rising stock too quickly.” In order to lock in part of his gain on a rising stock and combat this habit of selling a winner too soon, Darvas would use a trailing stop that moved in proportion to his position.


Endowment Effect

Darvas displayed classic signs of the Endowment Effect. For example, he states that “With no money involved I could easily control my feelings, but as soon as I put dollars into a stock my emotions came floating quickly up to the surface.” Simply put, the Endowment Effect asserts that when we own or create something we will value it more than objective observers.


Familiarity Bias

The Familiarity Bias was exhibited by Darvas in that he favored the familiar over new stocks at times. For example, he writes the following about Lorillard which he had traded multiple times over the course of time covered in the book. “I suppose I had a sentimental attachment toward it (Lorillard) because it has done so well for me the first time.”

Moreover, Darvas mentioned that after he began to make his first profits in some stocks “this led me to prefer these stocks more than others, and before I knew what I was doing had started to keep ‘pets’. I thought of them as something belonging to me, like members of my family. I praised their virtues day and night. I talked about them as one talks about his children.”

This sort of disillusioned hope in the future of the stocks Darvas owned only stopped once they started to create some of his largest losses and inflict emotional pain on him. This outcome resulted from having his beliefs cloud what should have been an objective assessment of price action.


Overconfidence Bias

Darvas talks about a period when he lost $100,000 over a few short weeks. He was out of sync with the market after he moved closer to Wall Street and listened to his broker’s advice more often. This close proximity created a false sense of assurance that eventually led to his overconfidence. He states “Now I know that my poor results were caused by egotism leading to vanity leading to overconfidence, which in turn led to disaster.”

Overconfidence bias will create an appearance of skill and mastery that does not exist. As a result, a trader will take on more and larger risks when there is no edge.


Managing your emotions and psychology are a key component in your trader development journey. The more aware you are of your biases the better equipped you will be to minimize their effect on your trading.


As always, please feel free to contact me with any comments or questions. Thanks for reading.


John

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