What Rogue Trader teaches you about cutting your losses

When things started to go wrong, Nick Leeson compounded the problem until it was too late, says Matthew Partridge.

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Rogue trader Nick Leeson ended up behind bars

Based on Nick Leeson's memoirs of the same name, Rogue Trader looks at the events leading up the collapse of Barings Bank in 1997. Nick Leeson (Ewan McGregor, pictured) is sent to Singapore to take control of Barings' trading operations. However, a series of disastrous trades leads to mounting losses.

While his reputation as a star trader allows him to fool his managers temporarily, the losses soon become too big to conceal, reaching £800m. He goes on the run with his wife, Lisa (Anna Friel). Shortly after Barings collapses, the couple are arrested in Frankfurt and he is extradited to Singapore.

The key moment

At first most of Leeson's activity is focused on carrying out simple orders for clients in the futures market. However, when a client wants Barings to help sell more contracts than the bank can realistically offload in the market, Leeson decides to buy them for the bank in the hope that he'll make a profit when the market rises. When the market falls instead, Leeson hides the losses in a trading account and keeps buying more in the hope than the market will recover. The Kobe earthquake then hits the market, augmenting his losses.

Lessons for investors

Warren Buffett famously said that, just as consumers like cheaper food, investors should welcome a fall in the price of shares because they allow you to pick up some bargains.

However, for most investors, doubling down on losing investments in the hope the market will recover is a bad idea. Not only does this tactic increase the risk that you will be completely wiped out by a bad streak of luck, but studies have shown that stockmarkets develop momentum in both directions, so shares that have slipped often fall further.

Other financial wisdom

Setting stop-losses, which automatically sell your shares if the price falls below a certain level, can also be a good idea from a psychological perspective. It forces you to look afresh at an investment rather than just throw more money at it.

Our tendency to cling on to losing positions is a manifestation of anchoring bias, the urge to measure the current value of an asset by the price that you originally paid for it. Of course, if you set the stop-loss too tightly then you could end up selling it unnecessarily after a minor blip.

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