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Thursday, January 24, 2008

Rogue Traders, Stop Losses and Averaging

Societe Generale Reports EU4.9 Billion Trading Loss (Update2):Societe Generale SA reported a 4.9 billion-euro ($7.1 billion) trading loss, the largest in European history, and accused an unidentified trader of fraud after wrong- way bets on stock index futures.

France's second-largest bank by market value plans to raise 5.5 billion euros from investors after the trading loss and subprime-related writedowns depleted capital, the Paris-based company said today. The Bank of France, the country's banking regulator, said it's investigating the situation.

The trading shortfall rivals the $6.6 billion Amaranth Advisors LLC lost in 2006, and is more than three times the $1.8 billion of losses by Nick Leeson that brought down Barings Plc in 1995. An offer by Chairman Daniel Bouton to resign after the trades were discovered this past weekend was refused by Societe Generale's board, the bank said.”

The fraud was discovered Friday and the trade was unwound Monday and Tuesday. Since it was a long index futures position, it might help explain the carnage in say, the DAX, Eurostoxx 50, and maybe even the lock limit down we saw on the S&P 500. Aren't forced liquidations fun?

Every trader should know these simple rules:

1) Have A Stop Loss
2) Never Ever Average Into A Losing Position

The first rule is never disputed by trader trainees, but the second always is. Averaging works nine out of ten times, but the ONE time it doesn’t, it more than makes up for all the other times it did work. All the blowups in history were trades that were AVERAGED until the traders and their respective institutions were all in.

Averaging into a WINNING trade is entirely acceptable and desirable.

BTW, that trader from Societe Generale is only 30 years old and he has now gone MISSING.

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