Are You An Investor Or A Gambler? The Story Of Isaac Newton

“I can calculate the motions of the heavenly bodies, but not the madness of the people.” – Isaac Newton.

If you are an investor without a strategy you are probably a gambler living in denial. Even the greats suffer losses, in the game of investment, a loss is inevitable. Strategy is king, perfect information, if it exists, is the difference between gains and losses. Investment can sometimes be the winner takes all.

If you have never heard of Isaac Newton (I am assuming you had basic high school education), it could be that you were half awake through your science classes or you have been under a rock for the past 500 years. I doubt the latter but the former is quite believable. Isaac Newton is probably one of the greatest analytical minds that have ever existed, his postulations and theories redefined science and formed the core of modern physics.

For someone with a keen eye for numbers and complex calculations, who would have thought he would be reckless with his investment decisions. Newton was no ordinary investor, he was the greatest mind of his time, how could he make what I term a “novice mistake”? News flash, he sure did. Man’s folly is not modern.

Isaac Newton experienced great losses in the stock market crash of the 1720s, today’s equivalent of millions of dollars in losses. To be candid, the market has no respect for anyone, absolutely no one, not even a man whose contemporaries regard as the greatest mind of his era.

Newton’s story was told by Thomas Levinson in his upcoming release “Money for Nothing”. According to Levinson, Newton in every regard was a cautious investor. Newton had a considerable amount of shares in South Sea Company- a mercantile firm whose trade interest span goods and slaves. His holdings were estimated to be worth around £13,000, today’s equivalent of £2 million.

South Sea Company backed by a well bribed British Parliament devised a scheme to convert debt holdings to equities. This was a scheme developed to prop up the value of their share price- financial gymnastics is not new. From a modest £100 a share in Jan 1720- Newton bought his shares at this price, to £325 per share by April, by May, SSC shares were trading as high as £487 per share. In Levinson’s words, “the boom delivered seemingly limitless wealth”. Are we sure the year 2020 is not 1720 in disguise?

Newton at first resisted the urge to sell, holding on to his shares. Like most investors, he finally gave in and sold his holdings for prices ranging from £400 to £500 per share. He pocketed a good sum in return, estimated to be about £20,000, a 200 year equivalent of his annual salary. As Newton was selling his shareholdings, so also was the price of SSC shares rising- market forces were driving the price, as demand was on the rise. By June, SSC shares were trading as high as £770 per share. Should Newton have waited?

Newton, like most investors, will be licking their wounds for selling too soon. Why did I sell it so soon? Will be a constant theme in his thoughts. He decided he wanted back in the game. By August, he started by buying SSC shares paying as high as £700 to £1,000 per share. Remember he bought first at £100 per share, sold at £400 to £500, netting a profit of £300 to £400 per share. Now he is buying back at £700 to £1000.

Would this decision come back to bite him? It definitely did. From a high of £700 to £1000 per share, by October 1st, SSC shares were trading at a low of £290- this decline wiped out the entire gain since the upward trajectory started. By November, it was trading for £200. Newton losses were catastrophic. He lost an equivalent of £20,000, if not even more.

If Newton, the greatest thinker of his era could make a catastrophic mistake, who says you and me are not susceptible. In Levinson’s words, “Newton had a simple explanation for his lapse. At the crucial moment, he’d lost his mind. Or rather, others around him had lost theirs”. Money can make you lose your mind you know.

The market has no place for emotionalism. The thrill of the moment got to Newton, I believe, or how best can you explain away how a man who made a profit initially from buying low and selling high, to wanting back and finally losing all. First, he must be an investor without a strategy or he was just overly greedy or maybe both were at work. If this had happened to a Nigerian man, we can point to his “village people”.

Newton’s mistake is still happening, more so at an alarming rate. 300 years have passed and investors’ behaviours haven’t changed a bit. Sophisticated finance models possessing predictive capacity never seen before are employed nowadays but the trend remains the same. Let’s hope 2020 isn’t reminiscent of the 2008 market crashes.

Are we gamblers or investors? Gamblers often tend towards what economist call the “gambler’s fallacy”. According to Investopedia: “Gambler’s Fallacy occurs when an individual erroneously believes that a certain random event is less likely or more likely, given a previous event or a series of events”

Flipping a coin 5 times and a head appears 5 times doesn’t mean at the sixth time a head or tail will appear. Each event is independent of the previous event. To make a decision based on previous outcomes for truly independent events is folly. The stock market is a perfect example.

This is where the complexity of investment lies, there are no rules cast in stone. We must understand that the market is cyclical: boom, bubble and burst. Understand market timing and always have a playbook.

Harry Markopolos, the acclaimed whistleblower of the Madoff scandal, once opined that any investment vehicle that can’t be explained in simple terms is probably not worth your time and money.

Nobel physicist Albert Einstein famously said; “God does not place dice”. If you would permit me to add a caveat, but humans do.

Strategy is king
Information is key
Hype is a red flag
Timing is important