An Algorithm Trader Who Single-Handedly Caused The ‘Flash Crash’

Flash Crash: An Algorithm Trader Who Single Handedly Crashed The US Market

11 years ago, on this day the US Market faced one of the most unprecedented events in its history of trading. Popularly known as Flash Crash, it is an event where market indices and stocks heavily plummet and then rebound quickly, all owing to ‘high-frequency trading’. It erased $1 trillion of market value in a single day! Read the story to find out how one guy did it all.

Crux of the Matter

What Is Flash Crash?
On May 6, 2010, major US Stock Indices including Dow Jones Industrial Average, S&P 500, and Nasdaq plummeted and recovered within an hour. Globally, it is regarded as the one of the most volatile trading days. Even though the indices rebounded the same day, the crash erased $1 trillion in market value.

Events As They Happened
The morning of May 6, 2010 was bearish due to the deteriorating financial situation of Greece and the upcoming elections in UK. Major equity and future indices were already down by 4% in the afternoon.

The Crash
Shortly after 2:30 PM EST, the markets became extremely turbulent. In mere 10 minutes, Dow Jones Industrial Average fell more than 1,000 points (pts), losing almost 9% of its value. Simultaneously, the equity market dropped by an additional 600 pts in 5 minutes, totaling the loss of 1000 pts. Post which, in just 20 minutes, the market regained most of the loss.

Driving Force Behind Such Volatility
In 2015, the Commodities Futures Trading Commission (CFTC) filed a civil complaint alleging that a man named Navinder Sarao manipulated the Chicago Mercantile Exchange’s (CME) e-mini futures contract by using spoofing tactics that led to the stock fall.

Let’s break it down!

  • CFTC: US’ derivatives markets regulator.
  • E-mini futures contracts: These are electronically traded, are listed on CME, and represent 1/5th of a standard S&P 500 futures contract.
  • Spoofing: A market manipulation technique to place and cancel hundreds of thousands of orders without executing any of them. A few market regulators also call it layering.

Filling an order book with sales order is not illegal. CFTC alleged that Sarao created a false supply to push the market down. He placed orders in a way they got cancelled as soon as the market came close to it. More than anything, it was the size of the order that effected. On May 6, Sarao put in orders worth $170-$200 million until afternoon – this amount included 20-29% of the sell-side order book. The orders were replaced/modified more than 19,000 times before being cancelled.

The Manipulation
Sarao sent large sell orders in the e-mini futures contract using layering algorithm to lower their prices. He repeatedly sold the e-mini contracts and bought them back at a lower price. He then turned the layering algorithm off, due to which prices rebounded and he sold the contracts at the higher price. He earned $6.4 million, or $530,000/day in 12 days.

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