In their book Sway, authors Ori and Rom Brafman describe the series of events surrounding the worst airline crash in Dutch history. Piloted by one of the most accomplished and experienced aviators in the world Captain Jacob Van Zanten, KLM Flight 4805 was on its way to Canary Islands. However, a bomb exploded in a flower shop closing the Las Palmas airport, and KLM 4805 along with several other planes was diverted to the island of Tenerife about 50 miles away. As the authors describe it, “Tenerife was a tiny airport with a single runway not meant to support jumbo jets.”
Sitting on the runway in Tenerife Captain Van Zanten realized that the crew was running into mandated rest period which under Dutch aviation laws was actually a crime punishable by jail time. Becoming more anxious by the minute the Captain agitated to resume the flight before it would have to be grounded on Tenerife which had no accommodations for the passengers. The air traffic control on the laid back island however, was listening to a soccer match and was in no hurry to move the planes. Finally just when it looked like the plane was ready to leave the airport became enmeshed in fog. The captain, utterly frustrated by this point decided to take matters into his own hands, put the engine at full throttle and decided to gun it down the runway despite the fact that he had no clearance for takeoff from the tower. What happened next was as tragic as it was predictable. As the fog cleared and the KLM plane was about to lift off the captain suddenly saw a Pan Am 747 parked at the end of the runway (it was in the wrong spot because of the fog). The captain desperately tried to lift the plane’s nose to clear the 747 but the underside of the fuselage ripped through the top of 747 and the whole crew and 584 passengers lost their lives.
The accident of KLM 4805 is a stark reminder of just how powerful and destructive the human instinct for loss aversion can be. Despite his years of experience the Captain was ultimately driven to his irrational behavior by his desire to avoid the massive delay and the inconvenience and loss of reputation that an overnight stay at Tenerife would entail. The end result was horrendous, but to many who trade it was not entirely unfamiliar.
How many times have we as traders seen the following set of events occur? We wake up, still groggy look at the FX market and without much thought put on a trade that promptly stops us out. Annoyed, we try again only to have the market dip to take us out once more and then reverse direction in our favor. Now getting really angry, we accidentally sell when meaning to buy and watch in disgust as we get taken out again. Now we double up the position and only succeed in buying the absolute top of the move watching in dismay as prices retrace and stop us out once more. Prices finally stabilize and we decide to buy one last time. We get long only to see prices drift lower once again. But this time we decide that the market will not play us for a sucker. We won’t get shaken out again, so we make the ultimate mistake we lift the stop from the trade and let it float in the market unprotected.
At this point the ending is just too predictable. The account crashes much like the KLM flight albeit with far less horrific consequences. However, the failure in both cases is due to our human instinct to avoid loss at any cost. In trading in order to win you must learn how to lose. No matter how painful, no matter how annoying, no matter how frustrating the process may be, you have to have a hard stop on every trade. A stop is an insurance policy against bankruptcy. As long as you’ve preserved a portion of your capital you can always come back. Ironically enough our basic instinct to protect us from loss will often lead us to the ultimate catastrophe of losing it all. As traders we should always be mindful of this trap if we want to succeed in the game
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