Let’s pick up on the tale I began to weave last week. If you haven’t had the pleasure of reading it first, do so. It provides the context needed for today’s takeaways. You’ll recall I took a portion of my hard-earned dough and invested it in hard money lending for an auto dealership. My cash was supposed to be used to provide financing for car buyers.

But the economic downturn threw a wrench into this company’s plans and rather than take the measures I outlined last week, the misguided captain at the helm of this sinking ship decided to double down. In so doing he essentially took a legitimate business and turned it into a Ponzi scheme.

First, he commingled funds from the auto lending with the real estate side of the business. He used profits from the parts of the business that were doing okay (auto lending) to pay out dividends to investors in the part of the company that wasn’t doing well (real estate).

On top of that, he used new investor money to pay the interest due to old investors. Provided you get enough new money coming in this Ponzi tactic should work, for a time at least. I suspect the hope was that eventually the real estate market would turn around and he would be able to back out of this cockamamie scheme and make everyone whole.

He followed the slippery slope until he was so deep that the only choice was to shut-down the entire enterprise. Naturally, lawsuits ensued, the company went bankrupt, and all its assets were liquidated at terrible prices due to the ailing economy. I think I received maybe 20% to 30% of my original investment back in the end.

If you want to feel sorry for someone, I suggest aiming that towards the retired investors that dumped their entire life savings into this company. Those are the true victims.

Don’t get me wrong, it sucked for me too, but I was in a far better position to handle the loss. I was young and only put a portion of my assets into this investment.

Bad Behavior Can Kill a Good System

The tragedy of my story is that auto lending is a legitimate business that produces consistent profits for investors if executed properly. That is the key! And it’s equally true of trading systems. Let’s use the Cash Flow Condors System to illustrate. First, like auto lending, it’s a system that has produced profits over time and will continue to churn out profits. Not necessarily every month, or even every year. But over multi-year time horizons, it’s a money maker.

But, sadly, people screw it up. Sometimes it’s ignorance. Sometimes it’s straight bad decision-making. In the case of my hard money lending, the knucklehead in charge should have followed the script outlined in last week’s article. He should have cut the interest payments to investors, then stopped paying them altogether, repossessed the cars from borrowers who defaulted, and at the end of the day investor monies would have remained largely intact.

I wouldn’t even have minded a 20% or 30% hit to my invested capital due to my understanding that 2008 was the worst recession since the Great Depression. But losing 70% to 80% of the money was not just unforgivable, it was unnecessary.

Similarly, you can most definitely screw up the Condors for Cash Flow system. The two biggest missteps that you must avoid are 1) taking max loss and 2) quitting.

By design, your potential reward per month is around $100 per spread, and your potential risk is $900. If you follow the rules, your loss should never exceed $350 to $400. But some traders, because they’re ignorant or misguided, or just can’t pull the trigger, will ride the trade to the bitter end and lose the entire $900. Like the Ponzi man in my story, they justify and rationalize until it’s too late. Taking the max loss just once on the Iron Condor can wreck your performance for one to two years.

Quitting is also a big no-no. You can’t stop after a losing month because you will never recover. To receive the rewards when the favorable conditions return, you have to be there! And that requires you to keep deploying condors through thick and thin. If it’s too painful, it’s because you’re trading too many contracts, plain and simple.

Do you think those who were lending money to car buyers returned to making money after the 2008 crises? Of course, they did! But not if they quit. And unfortunately, Mr. Ponzi man (and by extension – me) was forced to quit because of his mismanagement.

Remember these lessons, friends. And my pain will become your gain!

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