Don't Try This At Home: 9 Insights From The Book 'How To Be A Rogue Trader'

Kweku Adoboli

Photo: AP Images

Remember UBS trader Kweku Adoboli — the rogue trader who lost UBS $2 billion this year?How could you forget.

Adoboli, who is currently awaiting trial in London, was arrested in September for his fraudulent actions.

Of course, he isn’t the first, and he probably won’t be the last rogue trader in history.

Last month, Financial Times columnist John Gapper released an e-book ‘How To Be A Rogue Trader’ that delved into the psyche of rogue traders and how they devolve to such actions.

Business Insider was able to obtain a copy of the book to read and found some insight.

Most rogue trades are charismatic, clever and have worked their way up the ladder.

There are rogue trading cases that span the globe, and though the traders' nationality and culture differed, there were parallels between their stories. Here are a few points:

1. Rogue traders feel themselves to be outsiders.

2. Rogue traders are charismatic.

3. Rogue traders are clever.

4. Rogue traders have worked in the middle and back offices before.

Source: How to Be a Rogue Trader

The most destructive rogue trader in history is Nick Leeson.

In 1995, Leeson was a 28-year-old trader working in Singapore for London-based Barings Bank. He had accumulated £830 million in losses when authorities caught him in Frankfurt.

Leeson's losses bankrupted Barings, and the firm--then the oldest merchant bank in London--went out of business, the only institution to have been brought down by a rogue trader.

Former governor of the Bank of England Eddie George coined the term 'man's folie de grandeur' for Leeson's actions.

Source: How to Be a Rogue Trader

Rogue trading is a crime that seems to make little sense.

1. After so many high-profile cases of rogue trading throughout history, why don't banks do more to stop it from happening?

2. Rogue trading seems to have no rational sense, so why do traders continue to commit the crimes when they know they stand to gain little and know that they will eventually be caught?

Source: How to Be a Rogue Trader

Here's one theory on why this crime persists - there's an aspect of Darwinism to rogue trading.

Gapper cites several studies on sparrows and bees on when they switch from 'risk aversion' to an instinctive 'loss aversion' state of evolution-fuelled irrational behaviour in order to ensure survive.

Rogue traders are similar--they may initially panic at a small loss and hide them, then try to cancel them out by making big bets that may eventually turn into a pattern of prolonged irrational risk-taking. Eventually, the losses will build up to millions or billions.

Studies have shown that humans use emotional and instinctive regions of their brains when gambling instead of the region of the brain that controls logical reasoning.

Source: How to Be a Rogue Trader

Another theory: The bonus reward system and the trading floor culture can stimulate trader's risk-taking nature.

Traders see Wall Street as a place where if they have a good year and generate good returns, they're able to shoot up the status ladder. There is no 'working your way up' to them.

An academic study of over 50 Wall Street traders found that at the chaos of the trading floor is actually a 'highly organised, ritualized game.' And at the heart of it all, a trader's 'status' is at stake.

Source: How to Be a Rogue Trader

UBS, now infamous for rogue trader Kweku Adoboli, was a rogue bank long before that.

Swiss bank UBS became its current state through a series of mergers in the 1990s with Swiss Bank Coporation (which had just acquired London's S.G. Warburg).

But UBS' list of blunders before Adoboli stretches pretty far. It includes:

  • a $1 billion investment in Long-Term Capital Management, the hedge fund that was infamous bailed out after a bad investment in the Russian ruble in 1998
  • losing $38 million during the US financial crisis
  • and getting fined $780 million in 2009 for helping their wealthy clients in tax evasion.

Source: How to Be a Rogue Trader

Most rogue trading involves derivatives.

Derivatives are complex financial instruments in which the worth is determined by the quality of the assets they are derived from, such as loans and stocks.

Nick Leeson, for example, traded futures. And over-the-counter privately traded derivatives were one of the root causes of the 2008 financial crisis.

Source: How to Be a Rogue Trader

Rogue traders will always appear to trade in ways that don't look risky at all but...

Stephen Brown, an NYU finance professor, once gave a presentation on Nick Leeson's rogue trading and how it was fixed to make it look less risky and more profitable, something every bank values. So in the end 'the trader who is doing something wrong is the one who appears to be doing everything right.'

Leeson used a strategy called 'switching' where he took investor orders for index futures and used them to take advantage of tiny price gaps between exchanges.

The strategy made Leeson look like he had low exposure of volatility (low Value at Risk or VaR) and a higher excess return (the Sharpe Ratio).

Source: How to Be a Rogue Trader

Company heads shouldn't express shock when they find out about a rogue trader.

When a trader goes rogue--and before they are outed--the executives typically see signs of trouble or are told about dubious behaviour. This has been the case with almost every rogue trader. But usually, the executives chose not to investigate the matter or tell others that notice to shut up.

The book closes with the insight that banks acknowledges the risk a rogue trader may pose, but allow it because to have zero risk is not worthwhile.

Source: How to Be a Rogue Trader

UBS' rogue trader was just one of several financial gaffes this year...

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