Twenty-one years ago, Nick Leeson, a 25-year-old Englishman, began a job in Singapore as a derivatives trader with Barings Bank, a 300-year-old British financial institution. Barely three years later, Leeson began a 6.5-year sentence in Singapore’s Changi Prison after being convicted of forgery and cheating.
Leeson ended up losing US$1.2 billion of Barings money – nearly twice what the bank was worth – and put the venerable old bank out of business. Other traders have posted bigger losses. But Leeson’s brazen fraud and brash appearance made him the poster child for greed and stock market excess, and probably the most famous “rogue trader” of all time.
Of course, Barings – then one of the most venerable “old school” banks – was at fault too. They had almost laughably bad compliance and oversight. The bank’s biggest mistake was allowing Leeson to make the trades, and also be the pointperson in the back office and settle trades. This means that he had no one to answer to for what he did while in Singapore. This allowed him to manipulate trading accounts and hide huge losses.
Leeson used one of Barings’ error accounts – ironically account 88888, a supposedly lucky number – to make his increasingly large trades and hide his losses. Bad trades were supposed to be corrected every day, but he was able to manipulate things so no one at the bank’s London headquarters could see what he was doing. To meet margin calls that resulted from some stocks he bought going down in value, Leeson made headquarters think that their star trader needed money for legitimate trades.
Leeson’s mistakes as a professional trader were the same mistakes that cause individual investors to lose money – he just made them on a much bigger scale with a lot more money.
Here are five lessons an individual investor can learn from Nick Leeson:
1. Success sets the stage for failure – As we’ve written before, skillful investing is nearly impossible to distinguish from dumb luck. Leeson was a very successful trader at first. He was reportedly responsible for 10 percent of Barings’ profits in 1992 – a huge amount for one person.
Based on that track record, the young Leeson (still only in his mid-20s) was given a lot of freedom to trade complicated derivatives in the bank’s Singapore office. Leeson, and his employer, were fooled by his amazing success into believing he had unusual talent. But as it turns out, he may have had more luck than talent.
As the saying goes, “Don’t confuse brains with a bull market.”
2. Doubling down is a bad strategy – Some gamblers are seduced by the strategy of doubling down – when you have a loss, double your bet to get back what you lost. In the world of gambling, that is called a Martingale strategy.
Apparently, a lot of Leeson’s success in his early trading career came from “doubling down” when trades initially lost money. A trader who always doubles down on losing positions may make money and look smart, but only as long as his “luck” holds.
Once luck runs out, a string of losses leads to larger and larger bets. In a casino, the house shuts the gambler down when bets get too large. With traders, a brokerage firm needs more margin, stops any trading in the account and begins selling stocks in the account before the trader’s decisions become dangerous to the firm.
But, due to Leeson’s fraud – he could cover up his own mistakes – Barings had no clue.
3. If you find yourself in a hole, stop digging – By the end of 1994, Leeson’s losses had climbed to US$352 million. That’s a lot of money, but Barings could have absorbed it if they knew what was going on and put a stop to it.
Leeson was obsessed with recovering his losses, though.
The beginning of the end came in January 1995, when Leeson placed a huge long bet on Japan’s Nikkei stock futures (that is, he thought the Nikkei would go up in value). In a classic Black Swan moment, the Kobe earthquake occurred overnight, and the Nikkei plummeted.
As a result, Leeson was dealing with losses worth more than the value of the entire bank. So what did he do? He dug deeper and increased the amount of money invested in Nikkei futures to US$7 billion. He was desperately hoping the Nikkei would go back up and he would recover some of the money he lost.
But the market kept falling. Leeson should have cut his losses by having a good stop loss strategy.
On February 23, 1995, Leeson and his wife fled Singapore for Kuala Lumpur and eventually Germany. He left behind a note saying, “I’m sorry.”
After a brief global manhunt, Leeson was arrested in Germany. He was extradited back to Singapore for trial, and served four years of his sentence before being released for good behaviour. While in prison his wife divorced him. (He was also diagnosed with colon cancer from which he fully recovered). A film, “Rogue Trader,” was made in 1999 about Leeson and the Barings debacle.
Today Leeson is remarried, lives in Ireland, and gives speeches about his experiences. He also works for a debt advisory company.
4. Follow a disciplined, logical, investment plan – The whole Leeson/Barings debacle highlighted that a lot of trading firms needed better policies for controlling risk in their portfolios. But Leeson’s mistakes could have been avoided if he had a well thought out trading plan.
For one thing, Leeson should have known, and Barings should have told him, that always doubling down will end up costing them money. Cutting losses is one of the basic rules successful traders follow. Leeson was having none of that, though.
Also, Leeson didn’t respect the double-edged sword of leverage, or borrowing money to invest. Using leverage is a legitimate strategy that works great… when markets are going up.
It’s like someone taking out a mortgage to buy property and then “flipping” it, or reselling it quickly for more money. It only works when property prices are going up. If they start falling, the borrower is left with a property that’s worth less than what he paid and a large debt that needs to be repaid.
If an individual investor has a good investment strategy, they will know to cut losses and to use margin prudently. Leeson eventually learned this the hard way.
5. You don’t have to go it alone – What is striking about Nick Leeson’s time with Barings is that he did all his work alone – the very definition of rogue. As the bank’s losses spiraled out of control, he was by himself. Everyone at Barings, from management to coworkers, thought he was making huge profits. Even his wife was completely in the dark.
Tellingly, when Leeson and his wife fled town in February 1995, she insisted on first stopping by Blockbuster Video to retrieve a S$200 deposit. She had no clue that her husband had just lost US$1.2 billion.
Trading and investing can be emotionally taxing for anyone. In Leeson’s case, he was young, inexperienced, poorly supervised and emotionally isolated. Add in the fact that he had access to hundreds of millions of dollars of his company’s money and no one should be shocked that Nick Leeson made some disastrous, and very expensive, decisions.
For investors, the lone wolf style of investing is a bad idea. Discuss your ideas and plans with friends and mentors. Operating in secret is stressful and can lead to bad decisions. Don’t be like Nick Leeson and go rogue.