{"id":"600187c36cee0700069e4cef","slug":"flash-crash-en","title":"Flash Crash","audio_url":"https://hls.blinkist.io/bibs/600187c36cee0700069e4cef/600187c36cee0700069e4cf1-T1610713114.m4a?Expires=1643407148&Signature=M7BXo8RPlcQEsayvFnIdtjXRVlIP~gtnuVZIJiSpcfi7HQgxnVYpP0RqM0rzQV7fL1nax1gu9ixqSHWwfUus24wZ3fAdL~DB16xZKlW-X2W1g~kUMaKzE1JsX4z2BP29wyMERPORZ4hNHeoNrF7zAUfgGl0iXa~qo5WXyEM7VbbzN97om3eXVcUw9er5ENQSdZRJ~rx8-~UwSYcqZT-A9gw9Vkk7dtEZZdRq-qHkvmwNDpfX99vItclRsdsbUlBfoGeesHBc-JXN~Ls3RMS4AzS444hHD6O9dLfqg7BW5G1X9nB-WPdmIzJVkyzOzBjvXh2YjmhBx8RWDazknPHPwQ__&Key-Pair-Id=APKAJXJM6BB7FFZXUB4A","chapters":[{"id":"600187c36cee0700069e4cf1","title":"Fastest ever drop in global financial market baffles experts.","text":"

In 2010, the global economy was not in good health. Following the 2008 crash, the Eurozone was still in trouble, with Greece and Italy struggling in particular. The rest of the world feared contagion – even a little bad news had the potential to cause widespread economic panic.

This was the backdrop to the dramatic events of May 6 – an economic crash that happened so quickly that most people, even experienced market traders, missed it.

The key message here is: Fastest ever drop in global financial market baffles experts.

So, what exactly happened?

At 1:41 p.m. Central Standard Time, the S&P 500 index, which tracks 500 of the biggest US firms, dropped 5 percent in four minutes. The Dow Jones index tumbled along with it, falling more in five minutes than it had in its entire 114-year history. Individual shares plunged, too, creating stock charts that looked like sheer cliff faces. All across the world, from Shanghai to Frankfurt, the financial markets went into panic mode.

Then, the Chicago Mercantile Exchange, a global derivatives marketplace, had its automatic stop-logic function kick in, which stopped all trading for five seconds. When trading resumed, the markets miraculously began to climb again.

But in that 15-minute window, some very strange things had happened. Some shares collapsed to eye-popping levels – iShares Russell 1000 Value Index went from $50 to one ten-thousandth of a cent. On the other hand, shares in the tech giant Apple and the auctioneer Sotheby’s rose to $100,000 per share! The world had been turned upside down for a brief moment.

But these are all just abstract figures. What did this so-called “Flash Crash” actually mean for the people with money at stake? Well, many ordinary people all over the world lost out.

Take Mike McCarthy, an unemployed father of three from South Carolina. He had inherited a small stock portfolio when his mother had died the year before. As he watched the market slump, he panicked, then called up his broker and told her to start selling his holdings. Unfortunately for him, his order was executed just as the market collapsed. This cost him $17,000 – or the equivalent of eight months of his mortgage payment.

How had this sudden crash happened? At that moment, nobody knew.

"},{"id":"600187c46cee0700069e4cf2","title":"Gifted but little-known trader Navinder Sarao at heart of mystery.","text":"

Eventually, after the US authorities had learned a little more, the investigator’s trail led to Hounslow, a quiet suburban borough of outer London.

Here, in a small semi-detached house, 35-year-old Navinder Singh Sarao was living with his parents. He was the man US authorities believed to be the culprit.

But who was he?

The key message here is: Gifted but little-known trader Navinder Sarao at heart of mystery.

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. When he was three, he learned his times tables by playing an electronic game called Little Professor. At school, he found he could multiply long numbers in his head. He didn’t need to use paper to jot down his workings like other children.

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 – even if he’d seemed a little awkward and unpolished.

Housed above a supermarket in Weybridge, Surrey, the company hired wannabe traders and taught them everything they needed to know through an intensive training period.

After a short while, Nav began to settle into life at IDT, which, like many trading companies, was full of machismo. To escape this, he took his place at a lone desk at the far end of the trading floor, wearing heavy-duty ear defenders so he could concentrate better.

And then, deploying his mathematical brilliance, Nav began to trade the futures market. When Nav worked, everyone knew not to interrupt him. With his face pressed close to his two screens, he traded a futures contract of the S&P 500 index, known as the e-mini. And like this, he earned money – lots of it.

Very soon, Nav became one of the company’s greatest assets.

"},{"id":"600187c46cee0700069e4cf3","title":"Brilliant futures market speculator rivaled by new technology.","text":"

Compared to his fellow traders at IDT, Nav was an idiosyncratic character, who didn’t quite fit in. While many young traders liked to flaunt their new wealth, 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. What exactly did Nav’s work entail?

The key message here is: Brilliant futures market speculator rivaled by new technology.

Simply put, 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.

Here’s an example. A poultry farmer knows she will have to feed her chickens in six months’ time, so she agrees to buy some corn today for a set price. That way, if the price of corn rises between now and then, it doesn’t matter to her, as she’s already agreed a price. Of course, it’s also possible that the price of corn could fall, so she may lose out. But what she definitely gains is stability: she knows exactly what price she’s got.

A second type of investor has come along in the futures market: the speculator. If a speculator thinks the price of corn will go down because he’s heard there’ll be a good harvest, he’ll sell some corn futures so he might buy them back for less, later down the line. This kind of investor has no interest in the actual corn – it’s just another type of asset to bet on, like Microsoft stock or gold.

In the beginning, futures were traded on the boisterous trading floor. One of the founders of Futex, Paolo Rossi, began his career in the futures pit, as it was known, at London’s Royal Exchange.

But in the modern era, technology has made it possible for anyone with an internet connection to trade futures. 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.

Faster even than Nav.

"},{"id":"600187c46cee0700069e4cf4","title":"Cheated out of futures market, Nav devises way to game the system.","text":"

While a talented trader like Nav could react to new information in a fifth of a second, the new technology used in high-frequency trading responded in millionths of a second.

It became impossible for Nav to read the market reliably. Just as he’d settled on a bid, prices would begin to move against him. It seemed to him that, somewhere, invisible, powerful traders with their new technology could read his every move.

Quite simply, Nav felt like the system was rigged against him.

The key message here is: Cheated out of futures market, Nav devises way to game the system.

Before this, Nav had had faith in the market. It seemed that if you had talent, you could make money, regardless of the kind of background you came from. For a working-class boy, that was liberating.

But these state-of-the-art computer programs changed that. Suddenly, the market was tilted in favor of those who had access to the technology, like the big hedge funds.

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 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.

As a trading tactic, it’s as old as the hills. The English writer Daniel Defoe describes spoofing in eighteenth-century London. A governor of the East India Company, Sir Josiah Child, would get his brokers to look downcast and suggest bad news about a certain stock. This would cause other traders to sell off, driving the price down. Then, Child would swoop in and buy it at a discount.

Nav’s program, the Autotrader, essentially did this at super-speed. It would pack big orders on a futures contract, driving the price up or down, then automatically withdraw them before the price could be hit. Nav would then profit by swooping in with real purchase orders.

Soon, he’d managed to outsmart the algorithms. And he was making money – lots of it. More even than a professional soccer player.

"},{"id":"600187c46cee0700069e4cf5","title":"Authorities slow to track down creator of program suspected of crashing the market.","text":"

Nav turned his Autotrader program on, as usual, on May 6, 2010.

He’d left Futex some time before, and these days he was trading for himself alone. Nav preferred to trade from his childhood bedroom, at his parents’ house in Hounslow. On his bedroom wall hung a pair of pink soccer boots, signed by his hero Lionel Messi, one of the world’s greatest players. Nav was making nearly £900,000 per day, seven times what Messi earned at FC Barcelona.

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. Had he caused it?

The key message here is: Authorities slow to track down creator of program suspected of crashing the market.

In the immediate aftermath of the crash, rumors swirled around about the cause, going from a terrorist attack to a mistake by a lone trader. US officials soon struck on what they thought was the real cause: a large mutual fund called Waddell & Reed, which had sold an unusual amount of futures contracts that day.

A report published by two official commissions concluded that the crash must have been down to a perfect storm, similar to the complex situation that caused World War I.

But an anonymous trader living in Chicago, known only as Mr. X, dug deeper. Using his own software, he analyzed the data of the crash. What he found led him to believe that a single entity was responsible, though he believed the culprit was a big financial institution rather than an individual trader.

Mr. X presented his case to the Commodity Futures Trading Commission. After a prolonged process, it tracked down an entity called NAVSAR. Then, it traced this entity to the semi-detached house in Hounslow where Nav was living with his parents.

On April 21, 2015 – five years after the crash – British police officers knocked on Nav’s parents’ door. Nav’s father answered, gathered his composure, and called Nav down from his room. His son came downstairs bleary-eyed, in his usual tracksuit pants and sweater.

That was it. They’d got their man.

The official charge? Fraud and manipulating the markets.

"},{"id":"600187c46cee0700069e4cf6","title":"Navinder Sarao case prompts searching questions for world of finance.","text":"

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. The authorities had also found Nav disarmingly honest, which convinced them that he was someone they could work with.

But what else had they learned? There were several unanswered questions.

The key message here is: Navinder Sarao case prompts searching questions for world of finance.

The first question is: was Nav really responsible for the Flash Crash? One of the people who led the first probe into the crash, the economist Andrei Kirilenko, didn’t think so. He believed that Nav’s actions were not statistically significant in causing the crash.

The second question: was spoofing really such a bad thing? One renowned trader and hedge fund manager, John Arnold, argued that it wasn’t. In a piece for Bloomberg, he wrote that spoofing was a necessary counterbalance to the behavior of high-frequency traders, whose powerful algorithms damaged all other market participants. Spoofing offset that.

In the end, this argument became moot, because spoofing, along with the worst behavior of the high-frequency traders, was banned – directly as a result of the Flash Crash.

After all the dust had settled, was Navinder Sarao a hero or a villain? Many traders, after hearing his story, considered him an inspiration, and he became known as the “Hound of Hounslow,” after The Wolf of Wall Street, the film about stockbroker Jordan Belfort. He was the little guy, the David to the hedge funds’ Goliath.

However, Mr. X, the trader who’d contributed to Nav’s arrest, thinks the opposite. In his eyes, Navinder Sarao was a common criminal, who’d cheated ordinary people – not just high-frequency traders – out of money.

Another thing: the so-called Hound of Hounslow had not redistributed his wealth, like a modern-day Robin Hood. Mr. X argued, Nav had simply stolen money for his own personal gain. And what kind of a hero does that?

"},{"id":"600187c46cee0700069e4cf7","title":"Final summary","text":"

The key message in these blinks:

Navinder Singh Sarao, a mathematical genius from Hounslow, London, made a career for himself trading futures. Frustrated with the automated high-frequency trading methods he was competing against, he built a computer program that would outsmart them. It did, successfully, but may have helped collapse the global market in the process. His actions have had a lasting effect on the world of finance.

Got feedback?

We’d love to hear what you think about our content! Just drop an email to remember@blinkist.com with Flash Crash as the subject line and share your thoughts!

What to read next: The Man Who Solved the Market, by Gregory Zuckerman

Nav Sarao is seen as a hero by many young traders looking to beat the system and win big. He went from being stony-broke to making more money than his hero, the soccer player Lionel Messi. Six-figure profits were run-of-the-mill for him.

Another hero to many traders is Jim Simons, the groundbreaking mathematician and billionaire hedge fund manager. Something of an enigma, Simons is spoken of in reverent tones across the world of global finance. To learn more about him, head over to the blinks for The Man Who Solved the Market.

"}]}

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