John JefferyIt is useful to recall the Nick Leeson story to remind ourselves about what not to do in our own trading.
I won’t digress into the story of his life and the tragedy which ultimately flowed from his mistakes, but I will look at the parallels between Nick Leeson and traders of all levels. The main forces contributing to the trading environment that enveloped Barings’ Singapore office are ones we are all familiar with: Greed, Hope, then Fear.
Nick Leeson’s success on the floors of the London International Financial Futures Exchange (LIFFE) ignited his employer’s greed, resulting in his rapid promotion to the head of the Singapore office and an unprecedented carte blanche when it came to trading the futures exchange there. The predominant instrument traded was the Nikkei 225. During his tenure as the head of both trading and settlements, one of Nick Leeson’s colleagues made an error in trading. Rather than reporting this mistake, it was hidden in an account called ‘888888’. After finding such an accommodating and convenient carpet under which to sweep embarrassing losses, the ‘mistakes’, not entirely surprisingly, began to multiply and compound.
By December 1994, the red ink hidden in account ‘88888’ totalled some US$512 million. Getting increasingly desperate, Leeson made his Alamo and increased his positions in the hope that the Nikkei index would not drop below 19,000 points. At the time, this seemed reasonable as the Japanese economy was rebounding after a 30 month recession. Then on January 17 1995 a devastating earthquake measuring 7.2 hit the Japanese city of Kobe.
Chart 1 - Nikkei 225 Daily Bar Chart
click chart for more detailAs can be seen from Chart 1 the Nikkei was already in a downward trend. This fuelled the bad news sending the market down a further 7% in less than a week. Leeson requested extra funds to extricate himself from the negative positions. No stop losses were used, no options hedging, no trading plan. Just the emotion of hope. Hoping that the Nikkei would rebound post earthquake, Leeson bought around 20,000 futures contracts (each with a value of around US$180,000) in an attempt to move the market and dictate his will upon it. Needless to say, the market won.
In the week leading up to his disappearance (and short interlude as an international fugitive), it is reported that Leeson uncharacteristically threw up at his desk on a daily basis. Fear was now in control. The US$1.3 billion in debt and liabilities that he had run up was more than the 275 year-old Queen’s Bank could bear. Barings went under, with 1,200 people losing their jobs and numerous people losing their life’s savings.
Although the fraudulent nature of Leeson’s actions and the huge sums of money involved might seem to be beyond the comprehension of most traders, the three emotions which brought about the demise of this (admittedly very large) trading account are the same ones that we all experience every day. If an institutional trader, with all his knowledge, information and expertise, can fall prey to the basic frailties of human nature, what is there to prevent this happening to you?
I think you know the answer to that conundrum.
Stay Sharp
John Jeffery