Barometer of Fear

by Alexis; Stenfors

  Thus, different traders might have different attitudes to risk. More fundamentally, even a single trader might have very different attitudes to different types of risk. One of the strongest (and most dangerous) emotions is what we used to call ‘getting married to your position’. Sometimes it was possible to get so closely attached to a trading strategy or position that, regardless of how much the market consensus disagreed with you, you continued to fight tooth and nail to convince yourself that you were right. ‘The central bank will never cut rates,’ someone could say, certain that it was impossible for LIBOR to go any lower. ‘What could possibly go wrong?’ someone else might try to persuade themselves after having put an elaborate trading strategy into action. At times, traders could almost sound as if they were preaching to a group of new disciples, desperately wanting them to believe in the gospel they were delivering with absolute conviction. I am not referring to FX sales people trying to get clients to trade (that would simply have been classified as excellent sales skills), but about traders so fanatically obsessed with a trading idea that they had to be right. The global financial crisis was full of such behaviour. An endless list of traders refused to realise, for too long, how serious matters were – and how this would affect their trading positions. Others, like me, continued to believe in the apocalypse for too long. It is a classic mistake. In behavioural finance, it tends to be referred to as the ‘disposition effect’: traders often refuse to take stop-losses in time and therefore hold on to losers for too long – i.e. they become irrationally convinced that they will be able to turn their position around, just as gamblers on a losing streak don’t know when to walk away. It could also mean the opposite: that profits on brilliant long-term positions are closed out too early. Regret, or fear of regret at some point in the future, is an emotion that is common in dealing rooms as well.

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  All the theories outlined above have also been used to explain the behaviour of traders going rogue. A common feature of many major rogue trader scandals is that a very large amount of money has been lost, and that this process has, to some degree, been concealed from others. A rogue trader might deceive not only in order to be paid a larger bonus or be promoted, but due to guilt and to avoid losing face with their boss, family or colleagues. Losses might be allowed to escalate, and covered up even further, in the hope of a sudden turnaround in the market. It is convenient to think that traders, because of the job they do (buying and selling money), the things they make (money-related instruments) and the environment they work in (dealing rooms), make for perfect case studies relating to theories that deal with the ways in which people constantly juggle risk and reward. Rogue traders and other rotten apples could then be seen as extreme versions of such individuals: misfits who are prepared to put even more at risk while obsessively focusing on getting hold of more and more money. Add a few fictional characters at the end of the spectrum, and the extrapolation becomes both logical and hugely interesting.

  Based on my own experiences, however, these theories miss two important aspects of trading. First, they are too individualistic – people are perceived to think and act almost in complete isolation from friends and enemies, colleagues and competitors. Second, the (often monetary) reward is always seen as the motivation and end result. Risk taking is then perceived as a necessary evil to increase the likelihood of getting that reward. In reality, however, some people place a higher value on the physical and emotional experience of risk taking than on actually achieving the reward at its end.

  Take the example of a skydiver. What is the downside of voluntarily jumping from a plane at a high altitude? Potential injury or death, of course. What is the upside? Certainly not money. What is the downside of climbing Mount Everest? Frozen toes, perhaps even a devastating avalanche. The upside? Again, not money. In both cases, such activities not only cost a considerable amount of money, but sooner or later they run the risk of at least one minor accident. Car racing is also an extremely dangerous activity, and unless you belong to a select group of Formula One drivers, it is unlikely ever to bring in huge monetary rewards.

  ‘There is a percentage of people who want to be a little bit outside their comfort zone and I am one of them,’ Alain Robert, the ‘French Spider-Man’ famous for climbing skyscrapers without equipment or safety nets, once said. Cynical economists might argue that he repeatedly risks his life in order to earn sponsorship deals and make money from motivational speaking engagements, but that would be to miss the point. There are a number of people, both within and outside sports, who enjoy – or even love – taking risks. Sociologists sometimes mention professions such as undercover police officers, but also traders. Banks are in the business of taking risk in order to make money. However, not all bankers like taking risk. Banks, therefore, need to hire professionals who are willing to actively take risk. These people are called traders.

  Around the time of the 1997 Asian financial crisis, there was one chaotic Friday I will never forget. People were panicking and as a result were trading frenetically. As soon as I had traded with someone, or someone had traded with me, the Reuters Dealing screen and the switchboard lit up like a Christmas tree with incoming calls from banks, brokers and sales people requesting, even demanding, prices. The pace was relentless, and I did not have time to book one trade before the next one was done. Because I knew my overall position was good, I managed to keep calm. The market was heading towards chaos, which suited my trading book. However, I also knew that it was heading there too fast for me to be able to keep track of my position. The risk that I would make a calculation error and end up with a losing hand by the weekend (which was only a few hours away) was overwhelming. My manager saw what was going on and calmly sat down on the closest seat that happened to be vacant. He switched on the computer systems, tracked every conversation I was having and began to input the trades one by one – monotonously, quietly, as if he was working on a factory floor, completely unfazed by the several levels of seniority that separated us. On that day, I made more money than I was targeted to do throughout the whole year.

  On that Friday afternoon, however, I had begun to believe that the ‘trend had become my friend’. I did not close my positions. Instead, I hoped that Monday would deliver more of the same. But I was wrong. Instead, the market quickly swung all the way back to where it had started on Friday morning and more than 90 per cent of my profits were erased within a matter of a few hours. I was angry with myself and felt like a fool for not having been able to foresee the dangers in sticking to my risky positions. For a brief moment of time, I had begun to feel invincible, with a hubristic sense of self-confidence taking control of my actions.

  Most traders I know, or have known, are attracted to something that most people avoid like the plague: risk. Although they enjoy monetary rewards, they are often equally smitten by the buzz on the trading floor and simply playing ‘the game’. I don’t think greed was the only, or even the main, reason why I became so self-confident that Friday. It was something else: an incredibly strong desire to master something extremely difficult, to be proven right against almost impossible odds. Likewise, I never felt that my manager had taken on the boring work from me that day so I could make more money, which would in turn increase his own bonus at a later stage – a trading boss tends to receive a bonus based not only on their own trading performance but also on that of everyone below them in the trading room hierarchy. Rather, I knew that he had previously been in a similar situation, respected what I was doing, and was doing everything he could to enable me to make the right decision with regard to my own risk taking. It was my job and not his. In the end, I made the wrong decision, of course, and that decision was mine. But this was also a fundamental and integral part of trading. Risk taking is very individualistic. Ultimately, fear is an emotion and a very personal feeling.

  One problem with voluntary risk taking (or ‘edgeworking’, as sociologists refer to it4), whether it be in extreme sports or extreme trading, is that it is highly
addictive. If you get hooked, you want to do more of it. Alpine skiers, rock climbers and scuba divers I know or have met often talk about the importance of being able to ‘test your own limits’. Once a certain level of skill has been achieved, the ski slope or mountain needs to be steeper or the ocean floor less visible to even be worth exploring. Unfortunately, the same thing could be said about risk taking in financial markets. Doing the same thing day in and day out gets boring after a while. After all, you are paid to actively trade – paid to take risk – not the other way round. However, increasingly risky undertakings often involve accidents, stress, sleep deprivation and other physical or mental injuries. Trading might not seem like a physically dangerous job, but these are two sentences I wrote back in 2009: ‘I was exhausted’ and ‘The repetitive strain injury is better now, but I still suffer from stomach pain.’ Mentally, as I mentioned before, I was a wreck. However, even though such risks can naturally be seen as self-inflicted, or as something that ‘comes with the job’, risk takers often claim that it is those ‘who don’t know what they’re doing’ who are at risk. When, back in the late 1990s, I was told by one of my managers ‘Your position is massive’, I knew I had put on a risky bet. However, I had repressed the thought that I was betting against very experienced traders who knew what they were doing. I did not feel I was at risk; rather, I thought that they were the ones at risk. Such thinking can seem absurd coming from risk takers. Nonetheless, in my experience, it was surprisingly common for even the biggest traders to try to calm risk managers by saying that it was ‘the others’ in the bank or the financial markets who had no clue about assessing how risky a particular trade was.

  Risk taking often involves fear, and voluntary risk taking requires that to some degree you are comfortable with being afraid now and then – sometimes very afraid. However, you cannot ever become paralysed by fear. The riskier the jump from the plane, the more vertical the impossible ski slope or the deeper the ocean, the calmer you have to be in order not to panic. Traders need to develop an ability to maintain self-control in situations that verge on chaos.

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  On the morning of 11 September 2001, like most other traders in London, I was in the middle of trading. When the events in New York unfolded on the TV screens above the FX options desk around the time of the opening of the US market, most of us stood up and watched. It looked as if a missile had targeted the World Trade Center. But somehow it seemed too slow for a missile. I knew that Maria and our seven-month-old daughter were having lunch with an American friend she had got to know when we lived in Tokyo. I called and told her that a plane had hit one of the towers. ‘What kind of plane?’ she asked. ‘A small private plane making a terrible flight error,’ I told her.

  A few minutes later I dialled her number again, now with a very different message. It was clear that it was a commercial airliner that had hit the first tower and another aircraft had just hit the other tower. Simultaneously, Maria’s friend received a phone call from her husband who was a broker at Cantor Fitzgerald in London. I could only imagine what kind of distress he and his colleagues must have felt. I had visited Cantor’s head office once, and knew how high up their trading floor was located in the World Trade Center. ‘Why would anyone want to hurt us?’ I could hear Maria’s friend asking in the background.

  Around me, I could hear my own colleagues talking to their family members, telling them to switch on the TV. Others were frantically trying to get through to their brokers in New York, especially those at Carr Futures, the derivatives broking arm of our bank, which was located on the ninety-second floor of the North Tower. At the time, nobody had any idea who or what was under attack, let alone who or what the attacker was. But I remember feeling a sense of threat, wondering about the essential things that would be required if the financial system – or even our whole society – broke down. Cash and water, I thought.

  ‘Buy water and go home,’ I told Maria.

  There were so many rumours flying around in the market, each one more frightening than the last. I think most of us felt personally secure, but also that the City of London was unsafe. Being located next to the building site for the Gherkin skyscraper made it all the scarier.

  As there were no circuit breakers in the FX and money markets, trading continued. However, this was not business as usual. Trading-wise it was a blank sheet where traders tried to either eliminate risk or take advantage of the situation. Quite a few were trying to put bets on an imminent rate cut by the Federal Reserve. Eurodollar futures were being bought in the anticipation that LIBOR would collapse the next day. Soon, traders came to the realisation that this strategy was rather risky. If people were hoarding bottles of water or cans of food in New York or London, they would also hoard cash. And the cash everybody wanted during times of crisis was the world reserve currency: the US dollar. It was safer to bet on the fear in the market than on banks lending to each other at lower interest rates once the Federal Reserve had managed to cut the official central bank rate. That fear tended to result in a rush towards assets that were considered safe: US dollar cash. The focus quickly shifted to the FX swap market, where banks were able to borrow US dollar cash as long as they lent some other currency in return.

  The frenzied trading went on unabated until a senior manager stood up and announced that the trading had to stop. I think people higher up in the bank, not directly involved in the activities on the trading floor, had found it inappropriate considering the events that were unfolding. As a result, a hitherto unheard-of decision to halt the market making was taken. We were sent home. I switched off my computer screens, noting that not all traders in the market had received the same instructions. Some banks were still calling, desperate to trade no matter what.

  Not many hours were devoted to mourning and reflection. Within a couple of days, more or less normal trading had resumed. The fear, however, remained for weeks, months, even years. In the beginning, not a day went by without a rumour flying around that a suspect package had been found at Liverpool Street station, that a plane had gone missing or that George W. Bush had been assassinated. Unfounded statements, such as ‘Credit Suisse has been evacuated!’ or ‘The Bank of England is on fire!’, could quickly be verified by traders in London simply by looking out of the window. Sometimes, it was even possible to profit from others’ fear of an imminent attack, as traders in smaller and safer financial centres in other parts of the world regularly overreacted to such hearsay. In a way, it was better to be closer to the source of the fear, because then you could see or feel the reality on which it was based. Trades were also put on that would pay out in case of an attack, particularly ahead of weekends and holidays. In theory, there was a higher probability of an attack during any given weekend than, say, on any randomly chosen Tuesday.

  Looking back at this tragic historical event, I cannot help wondering how a ‘rational’ trader ought to have behaved on that day in September 2001. Tried to remain calm and simply follow the written and unwritten rules in trading and banking? If there was one moment when traders needed to put their emotions aside, this was it. Although I think that most traders managed to remain remarkably calm and controlled throughout the chaos that unfolded (nobody walked out of the dealing room in tears, which probably would have been a normal emotional reaction), I don’t think they were completely ruthless or inconsiderate either. Many of the victims were work colleagues, competitors or otherwise closely connected to the industry. Rather, it revealed how ugly the world could become if traders, having been programmed to take risk in order to make money for the banks, simply followed instructions. It was a day when rationality was at war with humanity.

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  Like competitive sports, trading is intrinsically very competitive. It is no surprise that a common expression for trading better than the average of everyone else is referred to as ‘beating the market’. Trading is a job where employers allow, encourage or pressure employees to be competitive on a daily basis. The average is not good enough, so
traders want to trade better than others, which, of course, improves the average with which you are compared. The average can be an abstract benchmark of some sort, such as an index. However, it can also be peers at other competing banks. Competing market makers can almost act as opponents. As a trader, you do not necessarily play in the same league or compete against each other all the time, but even so you often score points at the expense of an opponent – or the other way round.

  Although many traders and risk takers dislike each other personally (perhaps a rather natural outcome of such competition), they often show each other much more respect than they do people who do not take risk. This is why a derivatives trader might respect an FX spot trader, but not an equity analyst or sales person. Analysts and sales people are not risk takers. Risk managers, compliance officers, brokers and back office staff are not risk takers either. This, perhaps, could be a reason why traders are often perceived as being extremely arrogant and egocentric. I remember myself delivering monologues with a complete lack of self-doubt to colleagues, competitors, brokers and sales people. Often, the substance involved little of interest to people not working on the trading floors – although indirectly they were naturally affected by those thoughts and arguments should they evolve into actions in the financial markets.