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posted on 11 May 2017

The Classic Investing Mistake That Cost Isaac Newton Everything

by Staff Reports Money Morning, Money Morning

Money Morning Article of the Week

-- this post authored by D.R. Barton, Jr.

Sir Isaac Newton was unquestionably one of the most brilliant scientists the world has ever seen, famously remembered for formulating the law of universal gravitation, calculus, and even, you could say, all of modern science itself in his 1687 classic, the "Principia."

isaac.newton.2

But one thing you won't find jotted down in the history books is, despite his staggering genius, Newton was a lousy investor.

And I mean terrible.

This led him to make a catastrophic mistake - one investors still make every day - that essentially ruined him.

The thing is, if Newton had used a little of the methodical scientific skepticism he applied to, well, science, it might have saved him a fortune.

It's too late for Sir Isaac, of course, but I've got something to show you that can save you from the same miserable fate.

Newton Fell for the World's First-Ever Stock Bubble

Way back in the spring of 1720, the absolute hottest stock in all of Great Britain was the South Sea Company, officially trading as "The Governor and Company of the merchants of Great Britain, trading to the South Seas and other parts of America for the encouragement of fishing," which would make for one heck of a fearsome ticker symbol.

In terms of popularity, the South Sea Company was the Facebook Inc. (Nasdaq: FB) of its age, but that's really where the similarity ends.

The company was created to help consolidate and monetize British government debt - just like today, investors would get income on regular service of the debt.

But the bigger part of the investor attraction, the "upside potential" there, was the company's prospect of "absolute, government-guaranteed" monopoly on trade with South America.

So it was actually the prospect of a total trade monopoly that made the South Sea Company such a hot investment craze… and the first stock bubble in history.

And Sir Isaac Newton, by then a wealthy and famous man, owned a big position in the company.

In fact, he doubled his money - a 100% profit - after just a few months. He cashed out.

But he watched the share price continue to skyrocket as the company dealt in ever increasing amounts of British government debt.

Like many investors since, he was swept up in the wild enthusiasm of the market and bought back in… at three times the price of his original stake.


He was chasing a trade, trying to capture a new high - one of the absolute worst mistakes you can ever make.


By 1720, it was becoming clear that the South Sea Company's "prospects" for South American trade were not what was first thought.

What's more, the debt and stock markets were so opaque and chaotic, and so vulnerable to self-serving rumormongering and outright lies, that the shares essentially traded at more than 10 times what they were really worth.

This legal, government-sanctioned "pump and dump" operation was of course completely unsustainable.

In the end, the shares collapsed to only a hair above their "IPO" price. It wrecked the British economy and cost Sir Isaac nearly £20,000 - nearly $6 million today.

When the dust settled, this painful reversal led him to moan, "I can calculate the movement of stars, but not the madness of men."

He was chasing a trade, trying to capture a new high - one of the absolute worst mistakes you can ever make.

One of the greatest, wealthiest scientists of all time was totally undone by the one force guaranteed to prevent you from achieving your goals or drive you broke, even today…

Emotion.

When it comes to investing, we really are our own worst enemies. Our emotions get in the way and cause us to make highly irrational choices that are disastrous to our wealth.


Special message from the author:

Now, here's what you can do about it…

It Pays (Big) to Use a Totally Systematic Approach

So, the hard and ugly truth is that human beings just aren't "wired" to be good traders.

It doesn't come naturally.

Even in our most cogent, logical, or shall we say, "Newtonian," moments, our brains simply can't process the massive number of "inputs" required to make completely informed, emotion-free decisions. So we rely on shortcuts, rules of thumb, or "heuristics" (some of which we'll illustrate shortly).

These are not shameful crutches. Just the opposite, in fact. While they are mandated by our all-too-human limitations, they also illustrate our ingenuity - our ability to adapt and innovate.

But with investing, you can use a "system," one that you'll stick to, that will blunt emotion… and do so in a way that removes the chaos-triggering miscues from the trading process.

In the world of trading, with its ever-increasing complexity, systems play that role. They acknowledge our profit-crimping, loss-enhancing emotions. But systems are also innovative adaptations - powerful enablers that help us achieve far more than we ever could with our limited corporeal capacities.

In short, in the world of trading, a system can…

  • Act as a so-called "force multiplier" - serving as a proxy for an employee you can trust to "mind the store" while you're doing other things.

  • Help us make sense during periods of market confusion and force aside emotions that keep us from making logical, rational trading decisions.

  • Act as a safety net by telling us when we need to cut our losses short.

You see, a good system will insulate you from the three main flaws in human nature to which even the most intelligent investors, like Sir Isaac Newton, fall prey: the need to be right, perceiving nonexistent patterns, and focusing too much on results - the "small picture."

You can do the work to create your own methodical trading system, or you could use one I've created - I call it The 10-Minute Millionaire, because it's fast and simple to use.

It's a system that helped me quit my day job as an engineer to pursue my dream of trading full-time (although, the truth is, I usually make everything I need to in the course of a couple of hours).

It's easy. There are three steps to take, the math is "grade-school simple," and it's constantly at work so you don't have to be glued to a trading screen 24/7 - unless you love trading and you want to be there, of course.

It takes costly, ruinous emotion right out of the equation and shows you how to find the best of the more than 4,500 stocks out there to trade at the exact right moments.


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