Rogue Trading: A How-To Guide

Rogue Trading: A How-To Guide

CNBC_rogue_trading_Cover_v2.jpg
The revelation that a rogue trader at UBS lost billions has shaken the European banking sector and sparked cries for tighter regulation.Can't banks do anything to prevent traders from creating huge unauthorized exposures to trading losses? According to UBS chief executive Oswald Gruebel the rogue trading loss couldn’t have been prevented. “If someone acts with criminal energy, then you can’t do anything. That will always be the case in our business,” the former trader said in the interview publi
Photo: Insy Shah | Getty Images

The revelation that a rogue trader at UBS lost billions of dollars has shaken the European banking sector and sparked cries for tighter regulation.

Can't banks do anything to prevent traders from creating huge unauthorized exposures to trading losses?

According to UBS Chief Executive Oswald Gruebel, the rogue trading loss couldn’t have been prevented.

“If someone acts with criminal energy, then you can’t do anything.
That will always be the case in our business,” the former trader said in an interview published in the Swiss weekly Der Sonntag.

The UBS trader's alleged fraudulent trading bears a striking resemblance to that of Jerome Kerviel, the rogue trader from Societe Generale. Both cases bear more than a passing resemblance to Nick Leeson's rogue trading, which brought down the British bank Barings.

In fact, there's a surprisingly consistent pattern to all these rogue traders.

By John Carney
Posted 20 Sep, 2011

Get a Job on a Trading Desk

CNBC_rogue_trading_1desk_v2.jpg
Obviously, if you are going to become a rogue trader, you need to become a trader in the first place.
Photo: Yellow Dog Productions | The Image Bank | Getty Images

Obviously, if you are going to become a rogue trader, you need to become a trader in the first place.

Trade Things Your Bosses Don't Understand

CNBC_rogue_trading_2boss_v2.jpg
Both Kerveil and Kweku Adoboli were on "Delta One" desks, which trade complex over-the-counter derivatives that are supposed to perfectly mimic the performance of other financial instruments.They were complex enough that few people inside their banks understood how they worked. Which made it easier to ramp up risk without anyone knowing that's what was happening.
Photo: Tom Grill | Getty Images

Both Jerome Kerveil and Kweku Adoboli were on "Delta One" desks, which trade complex over-the-counter derivatives that are supposed to perfectly mimic the performance of other financial instruments.

They were complex enough that few people inside their banks understood how they worked. This made it easier to ramp up risk without anyone knowing what was happening.

Trade away from the home office.

CNBC_rogue_trading_3home_v2.jpg
It helps if you aren't in the home office. Nick Leeson was trading from Singapore for a British bank. Adoboli was trading in London for a Swiss bank. The physical remove seems to create barriers to enforcement.

It helps if you aren't in the home office. Nick Leeson was trading from Singapore for London-based Barings. Adoboli was trading in London for the Swiss UBS. The physical remove seems to create barriers to enforcement.

Know the Back Office Systems

CNBC_rogue_trading_4back_v2.jpg
Banks employ complex back office systems intended to make sure that traders are in compliance with all the internal rules and government regulations. Most traders never know much about these operations. The biggest rogue traders, however, have a deep knowledge of how these compliance systems work. They use this knowledge to anticipate how they could be caught breaking the rules and avoid doing anything that would raise a red flag.
Photo: Thomas Barwick | The Image Bank | Getty Images

Banks employ complex back-office systems intended to make sure traders are in compliance with all the internal rules and government regulations. Most traders never know much about these operations.

The biggest rogue traders, however, have a deep knowledge of how these compliance systems work. They use this knowledge to anticipate how they could be caught breaking the rules and avoid doing anything that would raise a red flag.

Have a Brilliant Idea

CNBC_rogue_trading_5idea_v2.jpg
Almost all the rogue traders begin with an idea, a belief that they understand something that is going to happen in the market that no one else understands.
Photo: Thomas Barwick | The Image Bank | Getty Images

Almost all the rogue traders begin with an idea, a belief they understand something is going to happen in the market that no one else understands.

They'll be the next genius trader, if it all works out. Huge bonuses, promotions, maybe even their own hedge fund will follow.

Start Small

CNBC_rogue_trading_5small_v2.jpg
Almost no rogue traders start with huge bets. They start by bending the rules, perhaps by making directional bets instead of fully hedged bets. Or putting more at risk than they are authorized. Or pretending that an order was placed by a client when it just wasn't. When they aren't caught, they start to realize that they can bend the rules even further.
Photo: Alberto Incrocci | The Image Bank | Getty Images

Almost no rogue traders start with huge bets. They start by bending the rules, perhaps by making directional bets instead of fully hedged bets.

Or putting more at risk than they are authorized. Or pretending that an order was placed by a client when it just wasn't. When they aren't caught, they start to realize they can bend the rules even further.

Trade With Other People's Accounts

CNBC_rogue_trading_6other_v2.jpg
A frequent tactic used by rogue traders is accessing other traders accounts. This is usually easy enough to do because people do not guard passwords very well.Sometimes junior traders are even told to "log in" to their bosses accounts to approve a trade. Other people have their passwords written on scraps of paper. Sometimes the password is just "Password."
Photo: Laurence Dutton | Getty Images

A frequent tactic used by rogue traders is accessing other traders' accounts. This is usually easy enough to do because people do not guard passwords very well.

Sometimes junior traders are even told to "log in" to their bosses' accounts to approve a trade. Other people have their passwords written on scraps of paper. Sometimes the password is just "Password."

If you Lose Money, Double Down

CNBC_rogue_trading_7double_v2.jpg
Doh! You suffered an unauthorized loss! Since you broke the rules when you lost money on that early bet, you need to cover your tracks.This means placing more phony trades, phony hedges, or calling real trades "errors."
Photo: Duncan Nicholls and Simon Webb | Getty Images

Doh! You suffered an unauthorized loss! Since you broke the rules when you lost money on that early bet, you need to cover your tracks.

This means placing more phony trades, phony hedges, or calling real trades "errors."

Cross Your Fingers

CNBC_rogue_trading_8cross_v2.jpg
Almost every rogue trader finds himself on a treadmill to Hell. In order to keep anyone from learning that they've suffered losses, they keep upping the ante.
Photo: STOCK4B-RF | Getty Images

Almost every rogue trader finds himself on a treadmill to Hell. In order to keep anyone from learning they've suffered losses, they keep upping the ante.

It's always possible things will turn around! Fingers crossed. Pray for miracles.

Enlist Your Colleagues

CNBC_rogue_trading_9enlist_v2.jpg
If you've lost enough money, you may have leverage over your immediate supervisors. The losses you have wracked up will likely cost them their jobs. They were supposed to be making sure this didn't happen! So now you may be able to get them to help you continue your scam.You're all counting on the idea that the market will make a turn in your favor. No one will ever know what happened.
Photo: PM Images | Iconica | Getty Images

If you've lost enough money, you may have leverage over your immediate supervisors. The losses you have racked up will likely cost them their jobs. They were supposed to be making sure this didn't happen!

So now you may be able to get them to help you continue your scam.

You're all counting on the idea that the market will make a turn in your favor. No one will ever know what happened.

The End: Confess and Point Fingers

CNBC_rogue_trading_10end_v2.jpg
If it goes far enough, you will eventually be caught. Even a bank as large as UBS will notice that it is losing billions through a London derivatives desk.Your best option at that point is to confess. Blame the pressure to produce gains, the lax compliance atmosphere, or even the supervisors who you brought in on your traders!
Photo: Paul Bradbury | The Image Bank | Getty Images

If it goes far enough, you will eventually be caught. Even a bank as large as UBS will notice it is losing billions of dollars through a London derivatives desk.

Your best option at that point is to confess. Blame the pressure to produce gains, the lax compliance atmosphere, or even the supervisors who you brought in for your trades!

A Better Option: Don't Do It

CNBC_rogue_trading_11dont_v2.jpg
You should be smart enough to know that genuine market arbitrage opportunities are few and far between. You're probably not smarter than the market. Making up for losses suffered is unlikely. So why not just try to make money within the rules? There's plenty of money to be made by traders at global investment firms. You don't need to shoot for the moon by going rogue.
Photo: UpperCut Images | Getty Images

You should be smart enough to know that genuine market arbitrage opportunities are few and far between.

You're probably not smarter than the market. Making up for losses suffered is unlikely. So why not just try to make money within the rules? There's plenty of money to be made by traders at global investment firms. You don't need to shoot for the moon by going rogue.