Today we talk about the story of Navinder Singh Sarao, a British trader known for being involved in one of the most emblematic cases of market manipulation through high-frequency trading (HFT) using spoofing techniques, iceberg orders and limit orders. He was accused of having contributed significantly to the "Flash Crash" of May 6, 2010, a sudden collapse of the US markets that lasted just over half an hour, temporarily erasing almost $1 trillion in market value. Sarao operated from his home in the suburbs of London, studying order books and using customized software (bots).
SPOOFING ORDERS
Placing large orders on the market with the intention of canceling them before they are executed ("phantom" orders). Through this technique it is possible to manipulate order books to give an illusion of supply or demand, pushing prices in a desired direction.
Sarao would place large sell orders (millions of dollars) above the market price to make it look like there was huge selling pressure, inducing other traders to sell. Once the price dropped, he would cancel the orders and buy at a lower price.
LIMIT ORDERS
Sarao used limit orders to control where his spoof orders were placed in the order book. This allowed him to create the illusion of market pressure without actually risking those orders being filled.
ICEBERG ORDERS
Iceberg orders only show a small portion of the order in the order book (the “tip”), while the bulk of the order remains hidden (e.g. buy after the dip). Maximum visibility on fake orders, buy with real orders after the dip.
CUSTOM BOT
His bot used 3 key principles:
1) Always stay at the back of the order book queue.
2) Cancel orders if the front queue is too short.
3) Ability to easily move orders up and down the book.
FLASH CRASH OF 2010
In an already fragile market (due to the 2008 crisis), on May 6, 2010, Sarao intensified his spoofing. He placed 2,100 orders for a value of over $120 million, in about 5 minutes his orders were canceled and reissued 604 times. After 4 hours, over 60,000 contracts were traded, Sarao cashed in about $1 million. His "ghost" orders, with a total value of $35 trillion, started a chain reaction between HFT algorithms (high-frequency trading with bots that execute operations in milliseconds: millions of trades in a few seconds) and quantitative funds, creating an instant collapse of liquidity (some stock exchanges blocked the operations). Asset prices fell and then quickly rose again, in what became the first devastating Flash Crash in history.
ARREST
Sarao was arrested in 2015, extradited to the United States. In 2016 he pleaded guilty to fraud and market manipulation but for cooperating with the SEC he received only 1 year of house arrest.
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