Are Rogue Traders Stealing Us Blind?

Author: Tex Norton
How many of you have had a real gut check on one or more of your trades? If you don’t know what I’m asking, you’re a newbie.

My experience came in the early 1960s. I’d already been an active investor for over 15 years. As a mechanical engineer, graphs and charts appealed to me. I charted High, Low, Close, Volume and Point & Figure daily for 120 stocks. You’re tempted to say “no big deal” today, but you must remember those were the days well before personal computers. We didn’t yet have the hand-held calculator. In retrospect, that was a major commitment of time for me. It was all done by hand.

The company was Fairchild Camera & Instrument. I’d been charting this baby for well over a year. When you do something like this on a daily basis, you tend to believe you “know” the company and its behavior. You think you have a “feel” for how the stock behaves. It took about 9 months for the buy pattern to develop. Normally, a three-top pattern gave either a buy or a sell signal. Over this 9-month period, FCI developed a 5-top pattern. Then it happened. The 5-top was exceeded by one; the buy signal. The STRONG buy signal.

I jumped in with both feet. Margin at that time was 50% and I used every nickel of it. I felt I was betting on a royal flush. I “knew” this stock. How could I loose? The buy price was $50.

I’m here to tell you that Murphy was alive-and-well even in those days. No sooner had I made my play, the stock turned around and started its downward trend. It then gave a sell signal because the drop exceeded the previous low by one. How could that be? The chart pattern just developed the strongest buy signal I’d ever seen. Now it says sell? Naw. Can’t be right.

I knew better. I followed that puppy down and down and down. Surly it would reverse any day now and prove that the buy signal had been correct. By the time the price had dropped to $34, I got a margin call. I knew better than to meet that call so I sold to cover.

No sooner had I covered than the stock price bottomed at $33.50, 50-cents lower than my sell price, reversed again and made a straight line northward to $100. I was right but I lost my shirt in the process.

Recently, I referenced Barry Minkow in another article. Barry was the teenager in Los Angeles who started ZZZZBest Carpet Cleaning and set the business world on its ear for a short period of time. Barry got himself into a similar situation but his solution was to emulate Charles Ponzi. Barry “knew” if he could just get past the current business reversal, he could pull-off a great comeback and no one would be the wiser. Instead, Barry went to jail.

I mention Barry because of something he said. To paraphrase: “No one starts out with the intention to defraud. They defraud because they think they can pull-off the correction with no one being the wiser and then be able to continue with normal business.”

That may- or may not be a true statement, but it probably answers the major question of why we are seeing so many rogue traders. I recently watched a movie about Nick Leeson, the rogue trader that single-handedly destroyed Barings Bank. Barings had been in business since 1762 but one young trader brought it down. Barings was ultimately sold to ING for a reported $1.

The movie portrayed Nick as a nice but very ambitious young man. The first time a series of trades went against him, he persevered and was able to recover. When it happened the second time, he thought he could repeat his first success. He couldn’t and didn’t’. The bank collapsed and Nick went to jail.

Why is all of this important? What does it have to do with you? I was betting a royal flush with Fairchild Camera yet I lost. Nick lost. Barry lost. How many times do you have to read about some one who was dead-sure he was right only to find out he wasn’t?

I was fortunate that I made my mistake early in life and I learned from it. Since I was only using my own money, no one else was hurt. It certainly taught me to be humble. I learned from my mistake and from then on, tried to learn from others’ without having to make those same mistakes myself. That’s the reason for this message.

Mistakes happen. Humans make mistakes. How you react and what you learn from those mistakes are what is important.

It wasn’t all that long ago that we “enjoyed” the Dot-Com bubble. A new paradigm. Everyone was getting rich. Can’t fail. And yet it did fail. I admit I was in awe of some of the profits I saw others making, but I also knew it wasn’t for me. I’m not that clever. I also knew it was not sustainable. That’s what experience teaches. That’s why a gut check experience is so important. If you learn from it, your chances of making another major mistake are slim.

More recently, we’ve watched the real estate bubble implode. Hey, I own lots of commercial real estate. Didn’t I get hurt too? No. Because I’d taken the time to learn how to invest in income property the correct way. This is a separate discussion by itself. The point is, really know what you’re doing before you bet the farm. And when you do bet the farm, always remember Murphy is watching.

Regards, Tex

This entry was posted on Sunday, November 1st, 2009 at 12:04 am and is filed under Authors, Economics, Tex Norton. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.