Flash crash – while working from parent’s home

The markets were not in the best conditions.

6th May, 2010.

Less than 2 years ago, the 2008 financial crisis had occurred.

Nobody had really recovered from that shock.

There was also the Greek economic situation – back in 2010. The fear was, that the situation in Greece could trigger another recession.

Some days are red (market below previous day), and some are green (market above previous day).

On 6th May, the US markets were in the red. Nothing abnormal.

Around 2 pm, the markets started falling further.

Traders, money managers, and investors watched their screens – confused, and worried. Nobody knew why the markets were falling.

Around 2.40 pm, without any visible reason, a massive drop occurred. Within 5 min, the market was down 9% in one day.

$1 trillion in value – wiped out.

And then, around 3 pm, an equally confusing thing happened – the markets started rising again.

By the end of the trading day, the markets were still down by around 3% – which happens sometimes, it is not that shocking.

The markets fell extremely sharply and then recovered.

Nobody could explain what really happened. People were making guesses. But nobody really knew for sure.

And so, the investigation started.

This was called the flash crash of 2010.

Investigation Starts

The authorities spent a few months investigating. Then, they released their findings.

On 6th May, a mutual fund company had placed large orders to sell some contracts.

To be able to sell, someone needs to buy. It turned out a majority of the buyers were High Frequency Traders (HFTs).

HFTs hold stocks for very short periods – often seconds or even milliseconds.

So the HFTs also started selling the contracts that they had just bought. Together, they were selling so many contracts, that it caused a massive sell-off.

This massive sell would have prompted enough investors to sell that the markets themselves tanked.

This report was criticized by many.

The argument was that the volume of selling was high, but not so high that it would trigger a mass sell-off.

Arrest

The investigations continued.

In 2015, a man was arrested in London from his parents’ house.

His name: Navinder Singh Sarao.

According to investigators, he was to blame for the flash crash.

How?

From his parents’ home, he would trade in the Chicago Mercantile Index (USA).

Navinder bought a software program to do his trades.

However, he did not use the software as it was. He modified this software.

HFTs are very commonly super-fast computers that do trades in nanoseconds.

They are so fast that no human can match their speed. That is one of the biggest advantages of these computers.

What they do is, they keep looking at orders being placed by others in the markets. Orders take some time to execute.

Based on the orders being placed, HFTs try to place and execute the same order much faster.

This way, they can do the same order before others – making a quick profit.

But these computers are still, computer programs. They’re not human. They cannot detect suspicious behavior or patterns.

What Navinder Did

Navinder used to trade from a room in his parents’ house – reportedly.

His modified software would place extremely large orders. And then, the orders would be modified/canceled.

But the HFTs had already noticed the orders – and started trying to do the same trade very fast.

So Navinder would not actually do the trade, but he would cause many HFTs to do that trade.

This is called spoofing the market. Navinder was spoofing the market.

Basically, he was causing the market to move in a certain direction using canceled orders – by creating artificial demand.

He could then use this market movement to buy and sell a stock/asset that he had in mind.

Of course, it is a bit more complicated than just that. But this is the gist of it.

He was found guilty. He already served some jail time by the time he was sentenced in 2020. He also paid heavy fines.

Rules and regulations were changed. Spoofing was made illegal. HFTs made changes to their programs too.

No More Flash Crashes

So does that mean flash crashes are history?

No. Not even close.

It turns out that in the modern world of computer-driven HFTs, things move incredibly fast – so fast that it takes some time to detect fraudulent behavior.

A few flash crashes and manipulations have happened over the years. And most likely, they’ll continue to happen in some way or the way.

For most regular investors, 2010’s flash crash did not really do much harm – markets went down, and then came up in an hour.

But for certain kinds of investors and traders, it can hurt.