‘Flash crash’ trader Navinder Singh Sarao has been bailed on charges of allegedly bringing down the US markets from his parents’ Hounslow bedroom. Does this show how vulnerable markets are?
What’s happening?
Day trader Navinder Singh Sarao has been bailed by Westminster Magistrates Court on charges of causing the 2010 ‘flash crash’.
US authorities claimed the Hounslow-based trader was responsible for the US stock market suddenly plunging by 9% for a brief period on 6 May, 2010. This reduced the value of the market by an estimated $500bn, and caused the value of the US dollar to fall by 4%. While it quickly rallied, the S&P 500 would still end the day down 3%, much larger than normal.
His cumulative activity over four years is claimed to have brought him around $40m in profits. For his part, Sarao has denied his involvement in any wrongdoing and has pledged to fight attempts to extradite him to the United States.
So, how is Sarao alleged to have done this?
The US authorities claim that between 2010 and 2014 he placed huge number of sell orders for E-mini S&P 500 contracts (futures contracts traded on the Chicago Mercantile Exchange). The FBI says that these orders were placed at levels slightly above the market price, and, it says, trading software was used to either cancel them or constantly adjust the price, so they were never actually executed.
However, the authorities claim that they were close enough to be visible to other traders, giving the misleading impression that there was a large seller in the market. This pushed the price down. They further allege that Sarao then profited by buying them cheaply (using a different program) and then selling them when the market recovered.
Could someone on his scale really bring down the markets?
The FBI statement argues that he “contributed” to the crash since his “spoof” sell orders alone were equal to the total number of orders on the buy side during the time that the market plunged.
As Jane Croft and Phillip Stafford of the FT report, there is a large amount of scepticism as to whether he was the most important cause of the crash. Indeed, experts have found it “hard to understand the US authorities’ actions”, with the head of one trading software company suggesting that the authorities “needed someone to blame” for the “embarrassing crash”.
Bloomberg View’s Matt Levine is also sceptical. He asks that “if his behaviour on May 6, 2010, caused the flash crash, and if he continued it for much of the subsequent five years, why didn’t he cause, you know, a dozen flash crashes?”
What were the regulators doing while this happened?
If Sarao really was a master manipulator, the regulatory authorities were very relaxed about it. The complaint states that the CME started querying his behaviour as early as March 2009, over a year before the crash. However, they apparently accepted his explanation that he was just showing a friend how other traders manipulated the market.
Sarao is also alleged to have boasted in an email to the software company that he had responded to further enquiries from them in May by telling them “to kiss my ass”. In May 2014, he admitted to the FCA that he had deliberately placed orders away from the market price, though without any assistance from software.
Michael Maiello of The Daily Beast thinks that such blasé behaviour, “is no surprise”. After all, “exchanges don’t make money by kicking people out of the game”.
Were there any other causes?
Another complication is that this new claim contradicts a report in 2010 on the crash by the US regulatory bodies, CFTC and SEC.
The report argued that the main cause of the flash crash was a decision by a mutual fund to sell a large number of e-mini contracts using a computer program. For some reason, the program decided to sell the contract over a 20-minute period rather than the five hours such a large transaction would normally take.
While it argued that computer-driven High Frequency Traders did play a role in making things worse, it focused on those traders who frantically bought shares only to resell them a few moments later (unlike Sarao, who only pretended to make offers). This meant that,“the same positions were rapidly passed back and forth”.
Finally, the volatility caused many firms to temporarily pull out of the market altogether, drastically reducing the number of buyers.