Wednesday, April 22, 2015

FLASH CRASH: The 36-year old day-trader supposedly behind the 2010 market meltdown

I happened to catch the nadir of the May 6, 2010 "flash crash" (screencap below with helpful background).

The Economist has a fascinating summary of the story behind the story. In a nutshell, a 36-year-old British day-trader named Navinder Singh Sarao, a British day-trader who the U.S. government wants to extradite on a laundry list of charges, was reportedly the trigger event.

Market watchdogs would not have expected the source of the "flash crash", as it came to be known, to be a lone trader based in a nondescript semi-detached house in Hounslow, an unfashionable suburb nestled between central London and Heathrow airport. But they would be less surprised by the methods he is accused of using, most notably "spoofing", a common form of market manipulation.

According to the charge sheet, Mr Sarao would routinely place a series of orders to sell futures contracts that would only be profitable if the S&P 500 share index fell. The authorities claim that a computer programme he devised constantly tweaked the price of his orders to ensure he wasn’t taken up on them. The effect, nonetheless, was to inject pessimism in the futures market, by making it look like lots of investors were expecting prices to drop. (Part of this bearishness spilled over into the stockmarket, causing shares to fall in price.) Mr Sarao, it is claimed, used this as an opportunity to buy cheaply...

...Mr Sarao appeared in court in London on April 22nd, but only to fight extradition. The American authorities claim he made a profit of just $879,018 from the trades linked to the flash crash—a pittance compared to the upheaval caused—though perhaps $40m from subsequent manipulation. Awkwardly, he funnelled his profits from trading to a firm called "Nav Sarao Milking Markets Limited", based in Nevis, a Caribbean tax haven, although he has no obvious ties to the dairy industry.

Why Mr Sarao’s continued use of similar trading strategies did not cause markets to convulse again is not clear. Nor is it established that he was the sole cause of the S&P’s swoon, as the American complaint in effect concedes. It claims he was "at least significantly responsible for the order imbalance that in turn was one of the conditions that led to the flash crash". That leaves plenty of blame to go around.

Regulators had previously thought a mega-investor such as a mutual fund must have had a hand in the mysterious event... That Mr Sarao might be even partly to blame will only add to the alarm the flash crash engendered. Many will ask how a single day-trader could possibly have been allowed to generate $200m of selling orders, over a fifth of the daily volume in the contract he favoured, during a period of known market convulsion without having been blocked by one party or another. The financial watchdogs, who had suggested the blame lay elsewhere, will also have questions to answer. The most pressing of them will be, if a trader from Hounslow can cause the S&P 500 to crash, who or what else could do the same—or worse?

Upon reading this, I immediately thought "Tyler Durden" of Zero Hedge. The financial website, in my view, was founded in part to warn investors of the dangers related to high-frequency trading (HFT), the programmatic bait-and-switch schemes used to manipulate markets.

Sure enough, Durden had the same idea I had:

So, uh, 5 years later we find that the SEC was only kidding about [their original theory], and that this time it actually has the right perpetrator... In any event, the market is now unrigged and unmanipulated dear retail investors, and the water is warm. Pretty please, because the banks, HFTs and hedge funds are desperate to sell some of the trillions in stock they have bought on the way up and without you there is nobody to sell to...

...Also please ignore the "fact" that we now trade in a world in which one (1) person can break the entire market...

...All joking aside, at least the CFTC finally figured out that it at least has to blame spoofing, layering, momentum ignition and every other aspect of HFT market manipulation on what Sarao was "doing." In fact, allegedly Sarao was doing this until a few weeks back, which suggests that not only one person crashed the market, but one person was responsible for manipulating it all the way to where it is now.

And yes, we are still laughing, because for the CFTC and DOJ to have the gall to actually bring up this charge against one person, indicates just how broken things really must be.

Then again, it was inevitable: just like the housing crash was blamed on 28-year-old Goldmanite Fabrice Tourre, so the Flash Crash had to be blamed on one person too.

One thing is certain though: when the entire rigged, fraudulent, manipulated market crashes and burns one final time, it will all be the HFTs' fault (as we have been saying since 2013), and not the central banks and their $22 trillion (more than the GDP of the US and Japan) in assets.

And who can't wait for an algo perp walk?

I, for one, blame Bush.

Hat tip: BadBlue Money.


Anonymous said...

What if these market manipulators are not lone wolves, but working for other people or a group?

bob said...

Why blame him for finding the system's weakness? The system is the problem.

Anonymous said...

Obviously an agent of Goldstein (1984).

What did this guy do that all the other HFTs did not?

Anonymous said...

ONE guy with a laptop and some software did all this by himself! Is the system that easy to screw up or was he that good or both?