Nav Singh Sarao is the Briton blamed for causing the May 2010 Wall Street ‘flash crash’ where about $1 trillion was briefly wiped out from U.S. stock markets in a matter of minutes.
Mr Sarao operated a one-man trading shop from his parents’ house in a working class London suburb, miles from the financial district. He showed few, if any, signs of wealth yet was making millions a year manually trading futures contracts by being quick with his mouse. He techniques were old school – buying big positions, holding them a very short time and selling them on intuition moments later.
This week Mr. Sarao was charged in separate civil and criminal complaints in the United States. He has been granted bail in London on strict conditions, including a $7.5 million bond. He has said he opposes extradition to the United States for trial.
So how does one man cause this much chaos in the financial markets, which are supposed to be safeguarded from events such as this?
The answer is that Mr Sarao was not the real cause. High Frequency Trading (HFT) firms are the real responsible parties.
HFT firms play elaborate games, using sophisticated computer software, to predate the markets looking for human trades they can front-run. By being faster than human traders – or each other – they have invaded the market, inserting themselves between legitimate buyers and sellers and taking a huge profit in the process.
These firms have rigged the market such that they can never lose.
Virtu, an HFT firm that listed publicly just 24 hours before Mr Sarao’s arrest (we’ll get back to this coincidence), has lost money exactly one day in the last 6 years. Citadel, another colossal HFT firm has a similar record and has now become bigger than most Wall St. investment banks. It enjoys a cozy relationship now with Federal Reserve, providing it de-facto government backing to conduct its activity.
The HFT firms rely on their computer algorithms to produce profit day in and day out on virtually every trade. They don’t lost and because of this have become very rich, very powerful and very connected.
Mr Sarao found himself, as a human trader, increasingly trading against these firms and their trading bots. The firms would duck and dive and weave around him, looking to steal profits on his trades. Mr Sarao spoke to his brokers on many occasions to get them to put limits in place to curb the abusive robotic traders but his brokers refused due to the massive commissions they earned from the frantic trading activity.
But Mr Sarao was smart. He worked with his broker to design three ways to place his orders into the market that made it difficult for these robotic trading firms to steal from him.
He then was able to trade effectively against the robots in a fair fight. As a successful, seasoned trader this was a fight he was able to win.
But the trading bots at HFT firms don’t react well to losing. As the losses at the firms mounted the bots engaged in increasingly strange behavior, effectively moving the entire market lower and lower and lower, trying to find the point at which Mr Sarao would capitulate.
But Mr Sarao was actually winning. So as the bots went lower he profitably traded the move. But as the contract they were trading, S&P futures, is influential in the market and used to price many other financial instruments, the sudden drop in price was noticed by other bots.
Fearing a loss other HFT firms joined in the selling. As traders up and down Wall St. picked up on this selling, they started to sell shares of actual companies, along with the HFT firms, fearing something bad was about to happen in the market.
The result was a 9% drop in the Dow Jones Industrial Average and the total estimated decline was worth approximately $9 billion.
The market had become so unstable because of the computerized trading firms that one single trader was able to cause a massive market panic simply because he had found a way to beat the robotic traders.
In addition to exposing the danger HFT firms cause in the markets Mr Sarao had also found a way to beat the firms. And to firms like Virtu and Citadel, who simply never lose, this was unacceptable. Sarao’s ingenuity made him enemy number one for the newly powerful trading firms.
The reason Mr Sarao is now in jail is because of HFT firms like Virtu and Citadel. These firms have infected the market, inserting themselves between legitimate buyers and sellers like a parasite. They control brokerages, trading platforms, regulators and state prosecutors.
They have turned this heft on Nav Sarao.
His indictment comes a mere 24 hours after HFT kingpin Virtu listed publicly, an unlikely coincidence.
Mr Sarao is nothing but a scapegoat for the events of May 6 2010. The real culprits are high frequency trading firms and the regulators that enable them.
These firms create instability in the markets and levy a tax against honest buyers and sellers of securities.
Our robust financial markets are vital to America’s success as a country. Faith in them makes them efficient and secure. HFT firms, not a single trader like Nav Sarao, give us reason to distrust the market and weaken them from the inside out.
HFT firms and the regulators who are asleep at the switch (or on the payroll) need to be held accountable for the events of May 6th 2010 not Nav Sarao.
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