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Expensive mistakes on the trading floor

When the stakes are high - as they are on the trading floor - how do you minimise mistakes and the risk of huge losses?

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In 1995, the actions of one man brought Britain’s oldest merchant bank to its knees.

Derivatives trader Nick Leeson incurred more than £860 million in losses for the Singapore branch of Barings Bank when he traded – without authorisation – almost the entire assets of the bank.

His actions were both reckless and illegal, bankrupting the 233-year-old bank and landing Leeson behind bars for four years.

In trying to justify his behaviour, Leeson later penned Rogue Trader, condemning the very practices that allowed him to gamble with such large amounts of money unchecked.

His critics branded him the gambling “barrow boy” at the time but Leeson contends to this day he “was just trying to put things right” when both luck and the markets turned against him.

LSE Social Psychology PhD student Meghan Leaver is hoping to pinpoint the specific human behaviours which lead to such incidents on the trading floor. To do this, Meghan is taking a novel approach, applying and adapting techniques for managing risk in the aviation industry.

Over the past year she has been gathering incident data from a London trading floor, separating technical slip ups from ‘human factors’  to investigate how human error shapes performance on the trading floor.

Some mistakes can simply be put down to “fat fingers,” when a lapse in concentration leads to a few extra zeroes on a trade and the risk of huge losses.

However, many errors occur due to teamwork and coordination problems among traders and between the three critical teams on the trading floor – the traders in the front room, the risk analysts in the middle, and the back office which looks after the invoicing and confirmations.

“A lot of the time, incidents are due to a breakdown in the segregation of these roles,” she explains.

“Traders and risk analysts in the middle office often do not have a shared awareness of how inter-connected they are, and many errors that result in financial losses occur due to misunderstandings between these teams.”

Although financial trading and aviation appear very different environments, they are both fast paced, highly skilled, technically complex, and dependent upon the social skills of operational staff.

Errors are caused by similar behavioural problems (e.g. problems in teamwork and decision-making) and Meghan is examining whether the methods used to improve risk management in the cockpit can be applied to the trading floor.

“Communication happens very fast on the trading floor and – similar to aviation – traders must manage risk under high levels of uncertainty and stress.

“To work effectively, traders and trading teams need the skills and attitudes that will help them to manage risk effectively and to respond to an uncertain and dynamic working environment,” she says.

To understand what these skills are, Meghan has logged around 1000 trading incidents and conducted focus groups and surveys with financial traders. She will analyse this data to explain why errors on the trading floor occur, to improve organisational systems for learning, and to develop an intervention for assessing and training teamwork skills.

“As with aviation, if we can educate traders on the importance of teamwork and the skills that make a good team player, the performance of trading organisations will improve markedly,” she says.

Meghan is expected to complete her PhD in January 2016. Her PhD supervisors are Dr Tom Reader and Dr Alex Gillespie.

Posted: 11 April 2014

Useful notes

LSE is hosting a public event with financial journalist and author Michael Lewis on 28 April. Lewis will be discussing his latest novel Flash Boys: cracking the money code about high frequency trading. For more information click here|.”

 

 

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