Exclusive: Michael Martin on What Makes a Rogue Trader Tick

“Unfortunately for those of us who are in the business, some of the most famous people associated with trading are the ones who have garnered the most press for horrendous and sometimes criminal activity. Names such as Kerviel, Madoff, Hunter, and Leeson conjure up images of some of the most fantastic losses of capital that the world has ever seen. You’ll never see a headline that says, “Trader Made 12% for 30 Years with Only 2% Drawdown: Clients Kiss His Feet, Rename Their Children, and Hand over Their Wives Willingly.”  – Michael Martin

Josh here.  I have a special treat for you guys this afternoon.  Michael Martin, professional trader and author of MartinKronicle.com is out with a new book from FT Press on October 6th.  His book, The Inner Voice of Trading, tackles an endlessly fascinating subject that all of us could stand to learn more about – the psychological aspect of how we trade and invest each day.

Michael has been kind enough to share the below excerpt about the inner workings of a Rogue Trader’s mind, very apropos considering the blockbuster revelation from UBS this past week.

Enjoy and don’t forget to pre-order your copy of The Inner Voice of Trading today. – JB


The Rogues

“The Rogues” on this list have lost enormous amounts of capital for their firms. In each instance, they cost many people their jobs and betrayed the trust of their employers and clients. These men did not act in a fiduciary capacity and did not put their clients’ interests first.

  • Jerome Kerviel, Societe Generale (SocGen): $7 billion
  • Nick Leeson, Barings Bank: $1.4 billion
  • Brian Hunter, Amaranth Advisors: $6.6 billion

They put their own egos first, their own aggrandizement. They went for the “hero trade” and, in return, caused catastrophic losses. Two of these firms, Amaranth and Barings, now cease to exist.

When their bonuses were in jeopardy due to their first large losses, these gamblers didn’t just double down, they went for broke. They tried to earn back their losses and then some, for the sole purpose of earning giant bonuses or to regain status and emotional victories. This is on top of the fact that they didn’t know how to trade; they blew up. Trading is about being self-aware to obtain profits in excess of losses. Gambling is about the emotional payoff.

Not on the list is Bernard Madoff, who, despite having committed a white-collar hate crime and stealing $50 billion, never traded – he just stole his clients’ money. He was a sociopath, not a trader.

Making money can be the result of either luck or talent. Since the Rogues blew up, I’m now convinced that they had more luck going for them than talent. Intention equals results. Behavior predicts where you end up.

Intention equals results. Behavior predicts where you end up.

Jerome Kerviel is the most sinister of the rogues. He falsified so many channels to get his trades through that it was like he was three people at the same time. That takes a special mindset, a virtual chess game in his head. Unfortunately for the bank, the money is gone.

Brian Hunter has to be the most egomaniacal of the group. Hunter decided to allocate between 50% and 65% of his firm’s assets in one trade. Rookie stockbrokers know better. I think that Amaranth’s principal, Nicholas Maounis should be held accountable, too. To not have firm control over his traders or his clearing arrangement is beyond dereliction of duty. The most basic prime brokerage statement delineates all the positions. How he could raise money after this type of oversight is beyond me.

My take is that Maounis didn’t want to take on Hunter emotionally and tell him to cut back on the risk. Maybe Hunter would threaten to leave, leading to bad press. I don’t believe that the cause for the losses had to do with the lack of risk control at Amaranth. Amaranth knew where the risk was. This was something being played out between Maounis and Hunter. It explains a lot of why Hunter was given control of his own trading – no one at the firm had the integrity to cut Hunter off.

Maounis was avoiding something emotionally by not taking action and cutting Hunter’s exposure. My inner voice tells me that you cannot let any one trader set the tone for the firm, no matter how well that person trades or what strategic advantage you think the trader brings to the firm.

The fact that John Arnold of Centaurus was said to be on the other side of the Hunter/Amaranth trade is not surprising, but it’s no consolation. When a trader lacks emotional intelligence and has no inner voice to listen to, he is more of a philanthropist than a trader. He’s giving money away, so it doesn’t matter who is on the other side of the trade, whether it’s one of the world’s best natural gas traders (Arnold) or a nobody. It doesn’t make a difference. The only cornerstone you get is for taking down the firm, not building it up.

When a trader lacks emotional intelligence and has no inner voice to listen to, he is more of a philanthropist than a trader.

The Federal Energy Regulatory Commission (FERC) has a $30 million suit against Hunter, and the U.S. Commodity Futures Trading Commission (CFTC) has already banished him and determined that he tried to manipulate the natural gas market. These types of trades cast a poor light on the rest of the marketplace.

Nick Leeson learned his lesson first among this threesome. He proved mathematically that Martingale systems, as they’re known, don’t work. In those systems, you double your risk level with each loss, figuring that, sooner or later, you’ll hit and get back to even. Most often, they are employed while trading against the trend of the trade and end with disastrous results.

Consider an example: Say that you lose $500 on a trade. The next trade, you risk $1,000. If that doesn’t work out, you bet $2,000. If that doesn’t work out, now that you’re down $3,500, you bet $4,000. Like I said, Martingale systems don’t work: It’s an emotional system of risk management that spirals out of control. Each trade brings financial havoc, which further perpetuates duress. If you trade against the trend with a Martingale ethos as Leeson, Kerviel, and Hunter did, you’ll bankrupt yourself, if not the first time you try it, then the second time, for sure. Only random luck is at play when such a strategy works out.

One point to emphasize is that these clowns didn’t deliberately trade a Martingale system, but this is what their emotions led them to do, whether they knew it or not. That’s how vicious a cycle it is if you don’t learn to take small losses and flush your ego. Traders don’t think it can happen to them, and then all of a sudden they’re emotionally invested in the outcome of a trade. A trader must detach emotionally from the outcome of any particular trade.

Invest in your process and stay out of the results. It’s a very sober way to trade and one that will keep you trading – and liquid – for a very long time. The concept of “Win it right back” is a death spiral. Keep your losses small, and you’ll never be in one.


Thanks Michael! 

Check out Martin Kronicle here

Get the book on Amazon here: The Inner Voice of Trading



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