Why do Rogue Traders still exist?

It’s been almost a decade since my last trade at the crosses desk, but still, the memories and experiences are as fresh as ever. As the adage goes: once a trader, always a trader. I do indulge in the odd trade to keep the art alive.

Even today, whenever I get a chance to speak on the subject, I get nostalgic about my trading days. This, despite the fact that I failed miserably as a trader like many others, not all of whom are willing to admit their failure publicly.  Some are silently accepting and others nod agreement after three or four rounds of exotic cocktails. Every trader undergoes the punishment of trading courses, tortuous technical analysis sessions and heavy duty lessons on the fundamentals of economics, but on the floor, will do what he always does; go by the hunch.  I, like many others regretfully never applied those principles to my trading strategies because on the floor only one thing works and that’s the intoxication of trading. Though most traders turn analysts on business news channels once they retire from active trading, at heart, they remain traders.

In hindsight, I sometimes wonder as to why and how rogue traders can still exist and that too in the most sophisticated of trading rooms! The recent case of a rogue trader operating at one of the largest Investment Banks was an eye opener as this institution has possibly one of the most sophisticated Treasuries around the world. One thing, which clearly comes out is that no amount of automation can eliminate the risk of rogue trading. Although treasury operations have evolved over the years and that too at an exponential rate, they are still susceptible to the flouting of the very basic principles of trading. What makes things worse is that most rogue traders are exceptional performers for their organizations and hence are rarely caught.

I remember the days when someone would physically check the dealer’s desk to see if something had not been entered or reported. Though it may sound draconian, the method was quite effective. We have travelled miles in search of the perfect trading room and foolproof risk management, but lost the essence in the process. We do look at Value at Risk figures but forget to look at dealers’ pads. Banks look at MTM, but not at unreported positions. We may have complex models for risk management but nothing can beat the human mind. Till such time we need human beings to trade, rogue trade and traders will exist.

Let me list a few basic but glorious principles of trading, which apply to all asset classes alike. These were flouted in the past and are surely being flouted by traders even today:

1. Buy low sell high: Every trader tries to time the market, but somehow “low” becomes the high of the day and “high” becomes the day’s low. It’s not a paradox. My experience tells me that most traders hate to admit to their craze for proving the market wrong.

2. Stop loss and take profit: Of course, every trader follows this, but in his own way. If a trade is in loss it becomes an investment and patience starts to wither the moment a trade is in the green. Seldom are these principles religiously followed unless cover trades for stop losses are automatically triggered.

3. Apply technical analysis: Though most traders talk about candlesticks, Fibonacci curves, Bollinger, moving averages and what not in public, on the floor, they go by gut feel.

4. Don’t trade before major announcements: For a trader that’s the opportunity to make big moolah and he can never let it go even though he might have been caught on the wrong side on a number of occasions earlier.

5. Never hide any trades: Most rogue trades happen because of fear or greed. If all the trades are reported on time, no rogue trade/trader can ever exist.

6. Take an occasional break from trading: It’s like telling an alcoholic not to drink. Traders do need to take breaks from the routine and distance themselves mentally as well as physically from the markets.  But in this age of technology, that’s hardly possible.

7. Refrain from averaging: That’s the fundamental rule of trading, which traders routinely flout, yet will not admit to doing so. Their usual reasoning is that they are accumulating at low levels.

8. Never over leverage: Leveraging has literally killed economies, yet there are no effective means to control it. It’s like a necessary evil that brings volumes and hence liquidity to the market.

9. Learn from mistakes: Old habits seldom die. Traders seldom acknowledge their mistakes and if at all they do, they forget about them at the next trade. It’s almost like they are perfecting their mistakes – an analysis of the behavior of any trader will show him committing the same mistakes over and over again over the years.

10. Do not over speculate: Never ever speculate beyond your means. Though every trader is a speculator to a certain degree, yet, over speculation can bring down a bank. Traders must not speculate beyond the limits stipulated by the bank and must assess the risk thoroughly.

Perhaps this reads like the first chapter of the trading manual and there’s a good chance it will be mocked by the trading fraternity. No matter. History shows that the circumstances around rogue trading are rich in oversight. We saw the clues but chose not to react. And when we did, the damage had already been done. There have been numerous occasions when rogue traders could have been caught, had we but paid attention to the telltale signs.  However, we conveniently chose to overlook them, as these were the guys generating phenomenal profits for the bank and bonuses of course!