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London man arrested over $40 MILLION HFT flash crash allegations

What's Navinder Singh Sarao said to have done?

What did our man actually do, then?

So, what is it that was allegedly wrong with Navinder Singh Sarao's scheme, if trading in this stuff is just ticketty and even boo? The specific allegation is “manipulating by spoofing”.

Instead of buying and selling in those two markets, which you can do quite happily, as a spoofer you set yourself up as normal in the first market and then make a song and dance about what you're going to do in the second. Move the prices but don't trade in that second market; you can then close out your now profitable position in that first one.

For example, you could have put options on the E-mini (the most liquid of the S&P 500 contracts) and then go and place massive sell orders in the E-mini futures market.

But don't ever allow those sell orders to execute. Stick them up for a millisecond or two, long enough for the other algorithms on the market to see them and adjust their expectations of prices, but not long enough (or, perhaps, close enough to the real market price) for anyone to trade on them. Close out the option as a result of the changed price and count one's money.

People are still, as they look at the report, disputing whether some of the spoofs did trade. On the one hand, if they did then Sarao should have lost fortunes. On the other, the CFTC evidence seems to indicate that some did.

The allegations are that this has been going on for years and that some $40m was made by doing it. A fair chunk of change, certainly, but the amounts being traded were truly vast. Some positions were $3.5bn.

True, those positions (or, in fact, spoofed positions; ones that are advertised but never trade) only exist for a millisecond or two but they are vast. In fact, on one day this one sole trader is alleged to have been 40% of all positions on said market.

High frequency trading is not the problem here

It's worth noting that this is only sorta to do with high frequency trading (HFT). The basic strategy has long been known. People have done it for donkey's years (and usually been punished when found out too; sometimes formally, others just excluded from markets).

Here it's that HFT was used to execute this old strategy: so it's not really evidence of the iniquity of HFT, no more so than someone nicking your Bitcoin wallet is evidence of something wrong with digital currencies. It's nicking wallets which is wrong, so too spoofing, not the particular technology by which it is done.

We might also note that the pickings are pretty slim. This is years' worth of putting on and off multibillion positions that exist only for milliseconds: it's making fractions of a fraction of a penny over time that adds up to that $40m.

This brings us to the flash crash of May 2010. That was when Wall Street simply nosedived for no reason anyone could figure out. Then it recovered – and all of this happened within minutes. Everyone assumed that it was the algos simply feeding off each other in a frenzy and, well, that's just what happened. However, the allegation is that this one trader caused this by his spoofing. Which is interesting because it means that the flash crash wasn't, in fact, caused by the inherent instability of HFT but rather by someone doing something we all already think of as bad: spoofing.

Finally, there's a difficult legal point here. Misdirecting someone in a financial market isn't illegal; that's part of the fine art of trading. It's no more reprehensible than selling a dummy pass. Grossly misdirecting them by spoofing may or may not be a crime. Depends upon the extent of it (as with pornography, know it when seen but can't define in advance). There's no certainty that the accused will be found guilty of a crime even if proven to have done what is alleged.

Navinder Singh Sarao denies the charges and has indicated he will contest American attempts to extradite him from London. ®


*Not quite – it appears to be one of two houses that his parents own.

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