When a billionaire trader loses his edge

May 4, 2012, 1:00 PM UTC

John Arnold

FORTUNE — Traders, when not speaking on the record, will sometimes allude to the search for a financial Truth — a belief that somewhere buried deep within the market there is a sweet spot that, if properly tapped, can unleash a fortune.

John Arnold, the 38-year-old billionaire gas trader who told his investors this week he planned to retire, was seen by many as the bearer of such a Truth. The celebrated necromancer of the energy market rose to fame in 2007, when he gate-crashed the Forbes 400 Richest Americans list as the youngest billionaire in the nation. And while it is likely that Arnold would scoff at the notion of a financial Truth, if there ever was one, it did appear to his trading brethren he was in possession of it.

“I have never seen such universal adulation of anyone in an industry the way I’ve seen people adulate him,” says an executive from a hedge fund that competed – and lost – against Arnold. “CEOs with their own private jets worship him. Grizzled traders act like 12-year old girls around Justin Bieber when he walks into the room. Someone this successful always has haters, but I’ve never seen him having any – and that is amazing for this industry. You know, people will extol Paulson or Soros and then whisper about them behind their backs. But the only thing they whisper about John Arnold is that he’s a freakin’ genius.”

The official story of Arnold is well-known: a star Enron trader who rose from the ashes of one of the most scandalous corporate bankruptcies in American history, launching his own Houston hedge fund in 2002 with the help of an $8 million bonus and a handful of early investors. While many were wary, Arnold took pains to distance himself from Enron’s blackened legacy and, within a few short years, extracted frothy profits, propelling himself to unprecedented fame and celebrity. (See this 2009 Fortune story The wunderkind gas trader)

MORE: Watch out! Is the Fed pushing us into another bubble?

In 2006, Arnold minted returns of 317%, net of fees, at his fund, Centaurus Advisors. At the fund’s zenith, it held around $5 billion, much of it Arnold’s own capital. Centaurus, which charged higher-than-average fees (3% for management and 30% of earnings) closed to new investors shortly after opening, but those who made the cut guarded their memberships fiercely, acting as though they barely squeaked into a VIP room from which they could easily be jettisoned.

What is less known about Arnold is his humble background and low-key personality, despite his formidable wealth and what all agree is a diehard competitive streak. While his number-crunching capabilities and trading prowess are legendary, his backstory is one of a painfully shy, middle-class kid who lost his father at the age of 17. The youngest of his family, he grew up in Pittsburgh and then Dallas, reared by a lawyer father and accountant mother. He was a sharp student who impressed his professors at Vanderbilt University, where he graduated with a degree in both math and economics in three years, and loved to play sports. But those closest to him are very protective of him, including ex-colleagues at Enron and his older brother, Matthew, who also traded at Enron. Even at Centaurus, his mother worked as an accountant.

At his fund, Arnold presided over a loose federation of mostly male traders known for their swashbuckling lifestyles and occasionally unruly behavior. Many of his hires were former colleagues from Enron or competing firms. In his role as head of the firm, he was revered as a king among kings. (See Arnold on Fortune’s 40 under 40 list last year)

Even the government regulators who once investigated his activities at Enron seem to hold him in high regard. In 2009, the Commodity Futures Trading Commission, the U.S. energy watchdog that once went after Arnold and other traders at Enron in the wake of the company’s spectacular demise, called him to testify on how the agency might better do its job. It is truly a testament to the small-world nature of the energy market that a trader once targeted by the CFTC would, seven years later, be sought out for his opinion as not just an equal, but an undisputed authority.

MORE: Dirty, dirty ‘hedge funds’

So why would a trader of Arnold’s caliber ever retire? Well, it has a lot to do with that competitive streak. Since Arnold’s passion is competing – and winning – recent years of diminished hedge fund returns have forced him to rethink the nature of the game. The natural gas market, his bread and butter, isn’t what it used to be, and the advent of hydraulic fracturing has placed hundreds of trillions of cubic feet of gas within easy reach of drillers. With supply looking plentiful for the foreseeable future, gas is no longer prone to the kinds of gravity-defying price spikes that once drew traders to it. This is good news for America, but not so great for hedge fund managers, like Arnold, who relied heavily on gas to fire their profit engine.

If there is one financial Truth, maybe it is that when markets are not longer easy to game, traders will no longer want to play.

But don’t bet you’ve heard the last of Arnold. The father of a growing family who signed the Bill and Melinda Gates and Warren Buffett giving pledge to donate a majority of his wealth with his wife, Laura, in 2010, has already taken a keen interest in philanthropy.