Can you imagine making a fortune from trading a casualty, like a natural event that places the odds in your favor overnight? In the undesirable case, could you imagine a natural event that unhidden your massive trading losses overnight?
These two scenarios happened to two traders who ended up trapped in a spiral of massive losses after astonishing profits. Although the chronology of their stories is different, both first won and then lost it all.
Which mistakes did they make? Let’s see.
A Natural Disaster Uncovers A Rogue Trader
Nick Leeson was a distinguished futures trader based in Singapore in the early nineties. His outlandish profits allowed him to earn a role as an account manager for England’s oldest bank, Barings Bank.
In his book, he admitted to having been lucky at his first trades, and his success was partly due to that fact alone. But his luck would face a pitfall when one of his co-workers made an error that translated into a notable loss that he would try to reverse.
Leeson strived to apply a recovery strategy through martingale methods, doubling the position size after every time he took a loss, only to find himself involved in much graver losses masked in an account never presented to his auditors.
An earthquake in Japan in 1995 aroused the pick around the Nikkei, where his ultimate bet was expecting a rise in the index. The Nikkei fell tremendously, taking his trading account to a point of no return, thus the Barings Bank bankruptcy.
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A Natural Disaster Makes A Trading Fortune
Brian Hunter experienced a slightly different order of events. First, this trader was in a losing position in favor of natural gas.
He had big-money bets on the thesis that the commodity price would rise, but it did not seem likely to be the case in the mid-term due to high production and supply.
However, in 2005, hurricanes Katrina and Rita devastated several oil pipelines, causing the gas price to rise from 6 dollars even to $14, making Hunter and his hedge fund, Amaranth, a fortune.
Hunter accurately predicted some other price changes later. But by 2006-07, his predictions were no longer as accurate. The natural gas market turned against his views, and he fell into the worst practices trying to avoid losses. Similar to Leeson, Hunter tried to recover from the first losses by doubling in the following bets.
Finally, Amaranth lost 6.6 billion, and Hunter got sued under claims of market manipulations.
Learning From Mistakes: Two Cases of Overtrading and Fundamentals Avoidance
What can traders learn from these two similar stories?
- Overtrading and trying to reverse losses would likely lead to even worse losses.
- Fundamentals have a lot of weight in market moves.
- Avoiding fundamentals leads to overtrading.
- Luck can play in traders’ favor but also against them.
- A contingency plan and cutting losses are better approaches to overcoming unexpected events.
Conclusion
The markets are unpredictable environments influenced by several factors, having the most impact on those related to fundamentals and news, like natural disasters. Trying to recover from losses can lead traders to lose all their capital.