Gregory LaBerta, a Special Agent at FBI has come up with a 35 page document that gives a detailed description of the trades executed by Navinder Singh Sarao, who is accused of playing a major role in the “Flash crash” on May 6, 2010.

I am surprised with this new finding as it comes out of nowhere and that too after 5 looong years. For the last 5  years, there has been a debate; the majority view being that the whole HFT community played a big role in the “Flash crash”. One could see harsh criticism on the HFT guys by academicians, low+mid frequency traders, regulators etc. Michael Lewis book on HFT created furor in the entire investing community. Now after all the noise,  FBI thinks that it is ONE guy ( who sits at his parents house with a couple of terminals + toxic trading strategies) IS mainly responsible for “Flash crash”.  Is it believable? Can one guy really destabilize the highly liquid E-minis market ? We will know based on the outcome of his trial.

What did the FBI agent find ?

  • Navinder Singh Sarao, the accused has been using manipulative trading practices since 2009. He operates alone, from his parents house in UK and trades through a broking account

  • Saroa trades futures in US and UK markets

  • Sarao’s broker supplied him some basic software to place trades. Sarao customized the trading software so that - he could place sell orders at multiple price points away from the best ask and automatically cancel as soon as the price moved towards his posted prices. Thus the fake orders created downward pressure on the existing price.

  • Manipulative Strategies used :

    • “Dynamic Layering” strategy : Place multiple orders at different price points in order to artificially move the market. In this strategy, the trader seeks to mislead and deceive investors by communicating false pricing signals to the market, to create a false impression of how market participants value a financial product, and thus to prevent legitimate forces of supply and demand from operating properly. The trader does so by creating a false appearance of market depth, with intent to create artificial price movements. The trader could then exploit this layering activity by simultaneously executing other, real trades that the trader does intend to have executed, in an attempt to profit from the artificial price movements that the trader had created.

    • Spoofing technique : Repeated placement of 188- and/or 289-lot orders on the sell side of the market, nearly all of which he canceled before the orders were executed

    • Large Bogus order :  SARAO “flashed” a large 2,000-lot order on one side of the market, executed an order on the other side of the market, and canceled the 2,000- lot order before it was executed. SARAO’s large, bogus orders had a tendency to effect artificial movements in the E-Mini market price by creating a false appearance of substantial supply or demand. SARAO could then exploit this price movement by executing a real trade on the other side of the market from his bogus, 2,000-lot order.

  • Lot of exchanges in US and Europe noticed Sarao ‘s toxic trading. Sarao always said he did the stuff manually and as long you do manually, it is hard to accuse someone.

  • Sarao lied to the exchanges and brokers that

    • he was merely using a few trades to explain to his friend the way toxic trades work

    • he was not using any automated software for executing trades

    • he was an old school point and click trader and he used a basic version of the software provided by his broker

  • Impact of Sarao’s trading activity

    • On the days he traded, the order book imbalance jumped from an average of 500 lots to 3000 lots

    • On April 27, 2010, he used Layering strategy and modified orders, 2000 times,  in a span of 7 minutes and made $800,000

    • On May 4, 2010, he used Layering strategy for 12 minutes and made $800,000

    • On May 5, 2010, he used Layering strategy for 21 minutes and made $400,000

    • …. the list goes on….

    • Intense trading activity in the hours leading to Flash crash. On the day of flash crash, Sarao’s trades accounted for 42% of all modification volume in the market.

    • Whenever there is a natural market volatility, Sarao’s tried to destabilize the market further to gain from it. He made most of his money in a year by trading on ~20 volatile days.

    • Overall, the report claims that Sarao netted $40 Million trading E-minis between 2010 and 2014. Incredible amount of money made by manipulating the markets

Who needs to read a crime-thriller nowadays ? Our world has people like Navinder Singh Sarao who indulge in activities that  can surprise many crime-genre authors.