Back in 1996 TurtleTrader was the first and only organization to break the inside story of the Barings Bank scandal. It was a great story about trend following success. The lessons of the incident are timeless.
Even though TurtleTrader felt the inside story was worthy of major news coverage, mainstream press only wrote about the young trader, Nick Leeson, who lost the $2.2 billion and ignored (to this day) who won the losses of Barings Bank. But, recently John W. Henry has finally confirmed what we first reported and explained back in 1996:
How are we able to make money by following trends year in and year out? I think it’s because markets react to news, but ultimately major change takes place over time. Trends develop because there’s an accumulating consensus on future prices, consequently there’s an evolution to the believed true price value over time. Since investors are human and they make mistakes, they’re never 100% sure of their vision and whether or not their view is correct. So price adjustments take time as they fluctuate and a new consensus is formed in the face of changing market conditions and new facts.
For some changes this consensus is easy to reach, but there are other events that take time to formulate a market view. It’s those events that take time that form the basis of our profits…Asia is another example of how one-time big events can lead to trends that offer us opportunity, and really shape our world. Whether you believe the causal story of banking excesses in Asia or not, there was a clear adjustment in the Asian economies that has been, and will continue to be, drawn out. Under these situations, it’s natural that trends will develop, and recognizing these trends allows us to capitalize on the errors or mistakes of other market participants. Because, after all, we’re involved in a zero-sum game.
Mr. Henry’s reference to a causal story and mistakes of others is very clear indeed. But even now, don’t hold your breath on The Wall Street Journal running a story. Our original story.
Why the Media Missed the Other Side of the Barings Story
The Barings Bank collapse in February 1995 was one of the most dramatic single events in financial history: a 233-year-old institution, banker to the Queen, destroyed by a single rogue trader in six weeks. Nick Leeson made excellent copy. The story of his hidden account, his escalating positions, his falsified records, and his eventual arrest in Frankfurt provided everything a financial thriller required.
What the coverage did not address was the question that the first line of zero-sum accounting requires: if Leeson lost $2.2 billion, who was on the other side? In every futures transaction, there is a buyer and a seller. Leeson was short the Nikkei 225, betting it would rise. When the Kobe earthquake struck in January 1995 and the Nikkei fell, his short positions produced losses that grew until the bank was insolvent. On the other side of those positions were participants who were long or who were short in the opposite direction. They captured the gains that Leeson’s losses produced.
TurtleTrader identified JWH as being on the profitable side of these trades in 1996, and Henry’s subsequent confirmation provided the clearest available public statement of why systematic trend following captured those gains. Henry’s framework is the most articulate available explanation of why trends exist and why they persist long enough for systematic approaches to capture them: because market participants are human and uncertain, consensus forms gradually rather than instantly, and price adjustments take time. That time is the window in which trend following operates.
The Asian financial crisis reference extends the same framework. Whether the cause is banking excesses in Asia or sovereign debt dynamics or currency misalignment, the mechanism is the same: a price adjustment that takes time, produces a sustained directional trend, and allows systematic approaches positioned in the direction of the adjustment to capture returns from the participants who are positioned against it. The errors or mistakes of those participants are not random. They are the systematic behavioral errors that loss aversion, anchoring, and herding produce. They produce the counterparties that trend following profits from year after year.
Frequently Asked Questions
Who won the $2.2 billion that Barings Bank lost?
Participants positioned on the opposite side of the Nikkei 225 and yen trades that produced Leeson’s losses. When the Nikkei fell after the Kobe earthquake, participants who were short the Nikkei or long instruments that benefited from the decline captured gains corresponding to Leeson’s losses. JWH, confirmed by Henry’s own subsequent public statement, was among the systematic trend following managers positioned correctly during this period. The zero-sum arithmetic is exact: Barings’ losses became other participants’ gains.
Why did mainstream media ignore who won the Barings losses?
Because the winner narrative requires explaining systematic trend following, zero-sum market mechanics, and the behavioral economics of how large market moves develop. The loser narrative required only explaining a rogue trader’s escalating gamble. One is a compelling personal drama that reads as a cautionary tale. The other is an explanation of how markets work that credits the beneficiaries of a catastrophe. Neither the drama nor the credit are comfortable for mainstream financial journalism.
What is Henry’s explanation for why trends develop in markets?
Because markets are driven by humans who are never 100% certain of their views, and the evolution toward a new consensus price takes time rather than happening instantaneously. During that time, price adjusts gradually as new information is incorporated and the consensus shifts. This gradual adjustment produces the sustained directional price movements that systematic trend following captures. The longer the adjustment takes and the more significant the underlying change, the larger the trend and the larger the potential profit for approaches that follow it.
Trend Following Systems
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