Trading psychology: They'll do it for kicks – until trading kicks them back

After the €5bn loss at Société Générale, James Moore looks at the 'psychological failings' of market operators and asks if London banks could do more to be rogue-proof
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The Independent Online

'Trading is fun. Ultimately, that's why we do it." That's how one senior, now retired trader at a leading investment bank puts it. But the fun also pays: by placing multi-million-pound financial bets, traders take a cut of the profits for their bonus if the deals go well.

This business is transparent and obvious: a trader makes £10m for his bank and then he gets a straight percentage. That's also why the culture on the trading floor is so hard, so driven and so risky.

Take the case of Jérôme Kerviel's trading at Société Gé*érale – the young French trader who lost his bank €4.9bn (£3.6bn). Mr Kerviel has claimed that had the bank stuck with his positions through the current market turbulence, it would have made a fortune. Other traders have privately agreed, arguing that the markets would have come back and SocGen, and its shareholders, need not have taken the multi-billion-euro loss they have suffered as a result of unwinding Mr Kerviel's positions.

The sort of people who go into trading has changed dramatically over the past 20 years but the psychology of the business hasn't. Once the "barrow boys" of the City, traders are typically young, hard working, hard drinking and hard living, with the salaries to pay for it all comfortably.

Trading floors are now much more diverse in terms of background than corporate finance departments, with some of the old barrow boys being replaced by a multinational collection of the best maths, hard science and engineering graduates – indeed PhDs – that money can buy. But in spite of that shift in their social make-up, trading floors are still the most egalitarian part of an investment bank; there may be triple Phds but there is little of the elitism, arrogance and snobbery found among corporate financiers. And the money for the top traders has got better and better.

Psychologist Jeremy Holt runs the Centre for Team Excellence, a consultancy service that aims to improve business performance, and works with traders at some of the City's biggest and best investment banks. He says: "The culture has definitely changed from what it was 15 years ago. If you think about it, when Nick Leeson was involved in the Barings collapse, there was much more 'open outcry' trading in pits. There was an advantage to being able to shout the loudest and intimidate people. These days it is all done on screens and it is much more technical.

"The kind of person who trades has changed too. They are all pretty clever – they have to be. They tend to be more like boffins than barrow boys. You find a lot of Phds on trading floors now. They will use complicated systems for tracking the way in which markets move and making their trading decisions."

However, while the loud and laddish culture of the floor may have been tempered somewhat, Mr Holt says traders are still subject to the same psychological failings that were common a generation ago. "They spend a lot of time thinking about their strategy and at what point they should go in, but they spend rather less time thinking about their exit. Humans have a natural predisposition to act in certain ways towards risk. We tend to be conservative when things are going well." The big risks, he adds, tend to be taken by traders when things are bad. "The problem is when what you should do tends to be the opposite of what you are predisposed to do."

He continues: "What people don't usually do is anticipate what they will do when the market moves against them. They can often come up with all sorts of reasons and data about why they should stick with a trade – why what is happening is just a blip and why the market will come back in their favour.

"It is because they have put a lot of effort into their trade and it becomes very difficult to abandon it. It hurts to do so. The difference between the good traders and the bad ones is they know this, they recognise this and they know when to get out."

And yet according to Mr Holt's analysis of trading psychology, SocGen may yet have cause to be grateful that it pulled the plug on Mr Kerviel's off book positions when it did.

Mr Holt makes one final, and very interesting point about how this crucial psychological failing comes about: the way in which traders are remunerated.

"If a trader makes €5bn one year, they would expect to get a cut of that in their bonus. Then if they do the same a second year, they would again expect a similar cut. But if they were to lose, say, €10bn, they would not necessarily be penalised. Over the three years, they will have made the bank a net sum of nothing, but they will have still made a significant amount of money."

The only penalty, of course, would be if they lost their jobs. But by then the bonus money would have been banked and the retirement home bought and paid for in their late 30s.

By their forties, they are too old for the fun game.

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