Flash Crash

Sharing my learnings from the book, Flash Crash by Liam Vaughan

Flash Crash by Liam Vaughan

On May 6, 2010, financial markets around the world tumbled simultaneously and without warning. In the span of five minutes, a trillion dollars of valuation was lost. The Flash Crash, as it became known, represented what was then the fastest drop in market history. When share values rebounded less than half an hour later, experts around the globe were left perplexed. What had they just witnessed?

• When Navinder Singh Sarao designed a program that could outsmart the markets, he seems to have also destroyed them in the process – at least, for a brief moment on May 6, 2010. This event became known as the Flash Crash.
• Navinder, known as Nav, was born into a working-class family to parents who’d moved to the UK from Punjab, India, in the late 1970s. A bright child, he showed an unusual talent for math at an early age.
• Later, Nav attended Brunel University, a few miles from Hounslow, and studied computer science and math. Like most of his friends, he was broke. But one of his housemates always seemed to have cash. Nav was intrigued and asked him where his money came from. The answer was trading. This was the beginning of Nav’s obsession with the stock market.
• Following university, in 2003, Nav found a job at a company called Independent Derivatives Traders. In his interview, Nav had impressed the company’s founders, brothers Paolo and Marco Rossi, with his lightning arithmetic. Very soon, Nav became one of the company’s greatest assets.
• Nav seemed to live entirely on McDonald’s Fillet-O-Fish sandwiches, and wore the same cheap sweaters to work every day. But he racked up massive profits for himself and the company, which by then had changed its name to Futex.
• futures are financial contracts in which one party agrees to sell something to another at some future date for a set price. The original purpose of a futures contract was to allow businesses to hedge against risk.
• At the Futex office, Nav did exactly that: he speculated on the fortunes of the American stock market – with unerring accuracy. But by around 2007, trading became harder for Nav. High-frequency trading was on the rise: a method that uses expensive state-of-the-art technology and algorithms that react to market conditions faster than any human being can.
• Nav felt increasingly as if he was being personally targeted and outsmarted by these powers. So he resolved to get the better of them. He reasoned that the computers might be the best at reading the existing data – but if he could influence the data itself, he could trick the machines.
• So, working with a computer programmer, he designed a program (AutoTrader) that could do just that. In the trading world, it’s known as spoofing: very simply, misleading other traders by placing orders and then withdrawing them. By placing a big order, you can influence the price of a particular asset. Soon, he’d managed to outsmart the algorithms. And he was making money – lots of it.
• As Nav’s Autotrader program placed massive orders, then removed them, the markets were already having a bad day. Then, one minute after he’d shut down the program – 1:41 p.m., CST – the markets began their massive crash.
• On April 21, 2015 – five years after the crash – British police officers knocked on Nav’s parents’ door. The official charge? Fraud and manipulating the markets.
• After four months in London’s Wandsworth Prison, Nav was allowed out on bail. Then, on November 7, 2016, he was extradited to the US to face his charges. Finally, in January 2020, he was sentenced. Rather than sentencing him to more time in prison, the Chicago judge decided to release him, on the condition that he spend a year under house arrest in Hounslow. The reason for this lenient sentence was that Nav had been very cooperative with the US authorities. He’d helped educate them on his spoofing methods, so they’d be better able to identify malpractice in the future.
• In the end, spoofing, along with the worst behavior of the high-frequency traders, was banned – directly as a result of the Flash Crash.