One of the reasons so few people actually trade their own accounts successfully has to do with the wonderment principle. The wonderment principle is simple. It happens the moment you think that your high priced broker in the $2000 suit actually knows more than you do. The moment you raise other people up and endow them with above average trading ability is the moment you are acting on wonderment principle. The wonderment principle guarantees that you will lose money because, instead of empowering yourself to learn about trading and then make your own decisions, you give the power of handling your own hard earned money to somebody else.
Considering how important money and having more of it is to most people, it’s interesting how pervasive the wonderment principle is. Its strength comes from people’s tendency to be lazy and to have low self esteem. Most people couldn’t conceive of offering their children over to someone else to raise 100% of the time, or their home over to someone else to design and decorate from top to bottom, or their purchase of a car to a mechanic. But when the wonderment principle kicks in, they are content to allow an expert to tell them what to do with their money.
An Excerpt from Fred Schwed’s Classic
Where Are the Customer’s Yachts?, Or, a Good Hard Look at Wall Street (Wiley Investment Classics) by Fred Schwed (originally published in 1940):
If you are a customer receiving margin calls there are a number of things you can do, but none of them is good. Probably the best thing to do is to use the Natural-Instinctive method. This consists of picking up a telephone and telling the broker to go climb up a rope, or do anything else with a rope that his fancy dictates, but you won’t send him any more money. This has some definite advantages, not the least of them being that it helps relieve the feelings. The broker will sell you out and will then mail you some odd change that is left over. Since this amount is too small to put back in the bank, you will probably do something really useful with it like putting linoleum on the kitchen floor. If the stocks that were sold out immediately start booming upwards again you can meet that difficulty by ceasing to read the financial page. The second method is to get hold of some more money (Lord knows how but you always can), and send it in. This is known as the Finger-in-the-Dike method. It is a curious and terrible thing, but for some reason it is easier for a man to raise a thousand dollars for a margin call than it is for him to raise the price of supper if he is starving. This method often works, but it is also the method used by suicides. The third method is surprisingly popular. This is the Head-in-the Sand method and is used by those many customers who have in them a strong dash of ostrich. As soon as they read in the paper that their stocks are down, they arrange not to hear about it officially. They refuse to answer telephones or accept telegrams, and in some cases actually make for the Maine woods. Just what they hope to gain by this procedure is problematic. What always happens is that the brokers sell them out as they do with those using method number one. However, the sell-out may come a little later, which means that instead of some small change remaining for the customer, the customer owes the broker the small change. Sometimes, long afterwards, the ostrich type of customer sues the broker in court, claiming that he never received proper notice of the margin call. If at that time the customer was deeply enough hidden in the Maine woods he probably didn’t get proper notice, at that. The customer can do all right in the lower courts, before a jury, because the only thing the average jury comprehends entirely in these cases is that they don’t like brokers. But if any real amount of money is involved, the broker appeals the verdict, and a higher court, without a jury, tosses the customer out. I once knew a professor of English literature who used to receive margin call telegrams which were sent collect. Not only would he put up the required margin but he would pay for the telegrams as well. While I have in general no useful advice on what to do about margin calls, I definitely feel that you ought not to pay telegram charges on them.
What Schwed and the Wonderment Principle Share
Fred Schwed’s 1940 book and the wonderment principle are eighty years apart in their language but identical in their diagnosis. Schwed’s three margin call responses, Natural-Instinctive, Finger-in-the-Dike, and Head-in-the-Sand, are three specific instances of the wonderment principle in action. In each case, the investor who entered the position under a broker’s recommendation has no plan for what to do when the position moves against them. The broker recommended buying. The investor bought. The price fell. Now what?
The wonderment principle produced the entry. The absence of an exit plan is its direct consequence. An investor who deferred the entry decision to a broker’s recommendation has almost certainly also deferred the exit decision. There is no stop loss, because stops require a plan, and the plan was “the broker says buy.” When the margin call arrives, the investor faces Schwed’s three options rather than a fourth option that Schwed does not describe: the investor who had a predefined exit rule and exited the position before it became a margin call.
The SNL stockbroker parody documented elsewhere on TurtleTrader, the Forbes articles on Roberts and Bernstein, and the Schwed excerpt all point to the same structural problem from different angles. The broker’s incentive is the commission. The investor’s incentive is the return. The wonderment principle is what allows the misalignment to persist: the investor’s belief that the broker’s $2000 suit indicates superior knowledge allows the broker to collect commissions while the investor accumulates losses.
Systematic trend following is the structural solution. Pre-defined rules for entry, exit, and position sizing eliminate the wonderment principle from the trading decision entirely. The entry fires when conditions are met. The exit fires when conditions are met. No broker’s recommendation is required or helpful. The rule is the broker.
Frequently Asked Questions
What is the wonderment principle?
The tendency to attribute superior knowledge and ability to high-status financial professionals, particularly brokers, and to defer trading decisions to them rather than developing and applying your own systematic framework. The wonderment principle is self-defeating because it transfers control of your capital to someone whose incentive (commissions) is structurally misaligned with your interest (returns), while simultaneously preventing you from developing the knowledge that would allow you to manage your own money effectively.
Why did Fred Schwed’s 1940 book remain relevant into the 21st century?
Because the structural relationship between brokers and clients, and the human behavioral patterns that make investors vulnerable to broker influence, have not changed. The specific instruments change. The margin call mechanics change. The broker’s suit costs more. But the wonderment principle that produces the deference, and the absence of exit planning that produces the margin calls, are features of human psychology that persist across generations and market cycles.
What is the alternative to the wonderment principle in trading?
Pre-defined systematic rules for entry, exit, and position sizing that do not require broker recommendations or real-time judgment calls. A trading system that defines what to buy, when to buy, how much to buy, and when to exit does not depend on the wonderment principle for any decision. The investor who applies such a system retains full control of their capital and has a specific plan for every market condition, including the adverse conditions that produce Schwed’s three margin call scenarios.
Trend Following Systems
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