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| How you could profit from rogue traders From Tom Bulford  Dear Golden Jann, “Gentle, selfless and kind”, said one acquaintance. “He was one of the good guys,” said another. “I can’t remember him ever doing anything wrong.” Well he just might have now! This paragon of virtue is none other than Kweku Adoboli – a man who is accused of losing £1.4bn of UBS's money. Ultimately though, I don’t really blame Adoboli. If you give somebody free rein to trade on financial markets and don’t keep a proper eye on them, this sort of disaster is inevitable. No doubt UBS’s bosses are desperately covering their own tracks while working out how they can pin the blame on Adoboli. Will they end up in the dock? This is just one issue for debate. Another is whether this is the tip of the iceberg. For every billion dollar trading loss, there must be several smaller incidents that have been swept under the carpet. Anything under a billion doesn’t rate a mention, I suppose. Coming just a few days after the Vickers Report recommended the ring fencing of UK retail banking from investment banking, the UBS fiasco could not have come at a better time. The question is: can anything be done to prevent this kind of fiasco in the future? Recommended The countdown has started… You have until 4pm on Thursday to see one of MoneyWeek's most sought after investment ideas first hand. Right now could be the perfect time to put this strategy in place. But you're already running out of time! Click here right away to discover how this could help your wealth grow – in 2011 and beyond. Your capital is at risk when you invest in shares, never risk more than you can afford to lose. Please seek independent financial advice if necessary. MoneyWeek Ltd. Customer Services: 0207 633 3780. How rogue traders get away with reckless gambling Vince Cable has coined investment banking as ‘casino banking’ but there is plenty of confusion about the true nature of the risk when it comes to trading. First there is the risk of the trading strategy. Although this is often described as ‘betting’ in fact a lot of these trading strategies are a form of arbitrage. Historic data spots a relationship between say, the price of gold and the price of gold shares. Computer-driven trading programs then look for small diversions from this pattern, profiting at the expense of others who have not spotted the relationship or cannot act upon it as quickly. In theory these strategies are low risk, but they can go spectacularly wrong. Maybe the historic pricing relationships do not persist. Maybe the computers are incorrectly programmed. Maybe the traders decide to override the computers and impose their own views. Then there is the risk that the trading room bosses don't know what is going on. It is probably no coincidence that Nick Leeson previously worked in the back office where the monitoring of trading positions is supposed to be taking place. He clearly found a way of hiding the extent of his losses, to the consternation of his bosses. So within the investment division of banks traders are pursuing strategies that might backfire, overseen by management that might not know what is really happening. But none of this need bother you or I so long as we do not need to foot the bill. This, of course, is why Sir John Vickers has recommended that retail banking be split from investment banking. This is eminently sensible for one good reason. How you could profit from the UBS fiasco Three years ago in Red Hot Penny Shares I said that “the activities of banks have far outrun the ability of regulators to regulate them.” This should be solved by ring-fencing retail banking. The regulator, the Bank of England, should easily be able to see where a bank is sourcing its deposits and how its loan book is split between mortgage, personal and commercial lending. This does not entirely preclude the possibility that retail banks will get into trouble, because the bank could be overly aggressive and the regulator might misjudge the risks. But by simplifying the whole process the Vickers proposals should avoid a rerun of 2008. But this will not prevent investment banking chiefs from trying to get a grip on their trading activities. They will be sweating with the fear that another Leeson or Adoboli lurks in their ranks, and desperate to get on top of the situation. The only way of achieving this is with specialist financial software that can track trades, calculate profit and loss in real time, and determine what might happen under different scenarios. This is a real growth area for financial software developers and one of the leaders is a company that I featured in the last issue of Red Hot Penny Shares. Not many will have celebrated the UBS fiasco – but I reckon that this little company is a sure beneficiary. To find out more about this great penny share, you can sign up to a free 3-month trial of Red Hot Penny Shares. Click here to find out how. Good investing. Tom Bulford The Penny Sleuth P.S. Got a comment on this article? Want to see what other Penny Sleuth readers thought? Leave a comment on the website, here. And If you are enjoying The Penny Sleuth... your friends, family and colleagues might too. If you know someone who might like to receive The Penny Sleuth direct to their inbox, simply forward to them this email and tell them to follow this link to sign up for free. And they could start to benefit, just like you. Red Hot Penny Shares is a regulated product published by MoneyWeek Ltd. Your capital is at risk when you invest in shares, never risk more than you can afford to lose. Penny shares can be riskier than other investments – they can be relatively hard to trade and if you need to sell soon after you've bought you might get less back than you paid. Please seek independent financial advice if necessary. MoneyWeek Ltd: 0207 633 3780. Share this article today:         |
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