Daniel Drew, 1797-1879: ‘He who sells what isn’t his’n, must buy it back or go to pris’n’

Hearing odd things about finance very rarely surprises me any more, but today I was told something that did take me aback and which might, I think, have some bearing on the behaviour of markets.

I was doing a speech at a training session run by ACI. I had arrived a little early and the organisers took me in to watch the trading simulation in progress. They had dozens of young professionals from various firms – some from banks, others not – trading away in a pretty sophisticated ‘paper’ market for EUR/USD over a fictitious (and hopefully not prescient) mock up of the news coming from a future ‘Frexit vote’. None of the people were traders in real life but they were learning how it all worked to help them later in tasks in HR, IT, Compliance and other roles.

There was a good deal of noise, especially from the table of ‘brokers’ connected by phone lines to their colleagues next door. It did my old heart good to hear folk shouting ‘50/54’, ’54 Paid’ as if they had been transported back to 1995. It would not have surprised me to hear Oasis playing softy in the background.

A number of people from ACI were running the simulation by pretending to be customers, by releasing the news, and by adjudicating disputes. All of them were market veterans. One of them showed me the chart of the price action over the numerous sessions that had been run during the week. In it, EUR/USD had trended higher.

That’s no real surprise, I was told. ‘We’ve run more than a hundred of these trading sessions over the years and no matter what the scenario is and no matter what the currency pair being simulated, in every single one, people start off buying the base currency.’  That is, they were always betting that the number they watched would go higher.

In response to my disbelieving protests, a number of the other veterans assured me it was the case. ‘To get the Euro to go down in one session,’ said one of them, ‘we had to say Russian tanks had crossed the German border’.

If they had told me that this had happened in the majority of occasions, I would have just shrugged. But every single time in over a hundred trials? If you think a bias towards ‘buy’ or ‘sell’ should be approximately a coin toss (and I was assured that the scenarios are – by traditional, professional measures – bullish and bearish in equal measure) then the chances of 100 buys in row is 1 divided by 2100 (or about 8 * 10-31).

Why did they think this always happened? Their best guess was that people were uncomfortable ‘selling’ and being short. They liked to think that they owned an ‘asset’. This despite the fact that the trading was purely make believe and, even if it had not been, being short EUR/USD necessarily means being long USD.

If they had been trading equities, I can sort of see why they might do so. Shorting – even for pros – is trickier than being long. And there is an age old (in my view unfair) cultural bias against the bear trader: the saying, ‘He who sells what isn’t his’n, must buy it back or go to pris’n’ dates from the 1800s.

This got me thinking. Does this bias to the long side translate into markets like FX even when it is fundamentally meaningless? Clearly the people involved in the trading game were not professional traders: ‘On the first day, they haven’t a clue; they are scared to make a rate or do anything’. And I was told that the buying bias tended to diminish as the week of training went on.

But could there be an unconscious bias for inexperienced, real life traders to be long ‘the number’? If so, it could affect retail FX quite heavily – most retail traders are newbies. They just don’t last long before they burn through their capital and they are replaced by new, willing participants. This happens because they have no edge and super-high leverage.   But, while they survive, if they have a bias to be long ‘the number’ this could have a significant impact; the importance of retail flows in FX has grown a lot and is still rising – 10% of spot flows or more.

Indeed, the most important common retail position in the most important retail market of all – Japan – is long USD/JPY. This has always been explained as a ‘carry trade’ (own USD and earn higher interest than you pay on the short, ZIRP’ed JPY). But could it instead simply be because Japanese retail punters – like the inexperienced traders in the ACI game – on balance just feel more comfortable ‘being long’?

In truth, I don’t know the answer and I don’t have the data to say anything much more meaningful than I already have. But there is a lot of work being done on behavioural finance at the moment. If anyone reads this blog piece and goes away and gets a juicy PhD out of the research, please remember my name.

When you graduate, you can buy me a pint.