Who Else is to Blame for the Flash Crash?

It's hard to say if the trader who may have caused the flash crash will be convicted -- but who else should be held accountable?

Apr 23, 2015 at 10:01 AM
facebook X logo linkedin

It's five years later, but at last we know exactly what caused the flash crash (wink, wink). This, from Bloomberg:

"According to the U.S. Justice Department, London trader Navinder Singh Sarao earned $40 million from 2010 to 2014. His product of choice: CME Group Inc.'s E-mini futures on the Standard & Poor's 500 Index, the key measure of U.S. stock prices. He traded so much, the U.S. government says, that he contributed to the flash crash of May 6, 2010, that briefly drove shares into a nosedive that erased nearly $1 trillion in value.

"Sarao, according to the complaint filed in a Chicago court Tuesday, used strategies known as spoofing and layering -- putting in fake orders to drive prices in a favorable direction -- to manipulate trading on CME's Globex market, one of the most important in the world. He would pin his manipulative quotes just above or below current prices to trick other market participants into thinking futures were poised to move. Sarao allegedly posted those orders with no intention of executing them.

'With the aid of an automated trading program, Sarao was able to all but eliminate his risk of unintentionally executing these orders by modifying and ultimately canceling them before execution,' the Justice Department said in its complaint. 'Meanwhile, he exploited his manipulation to reap large trading profits by executing other, real orders.'"

Color me unconvinced. I'm no lawyer, but I would assume "spoofing and layering" is not legal, provided the "spoofer and layer-er" fully intended to never execute the orders. But how do you actually prove that the guy sent in these orders with the full intent to never execute them? Even if you can prove that, how is he different from countless other algos? It's my understanding that they routinely probe markets to feel out liquidity and whatnot. Was this guy trying to exploit the probers and basically put them all on "tilt" at once?

That's more or less what happened (they say) in the actual flash crash. The machines all started lifting bids and selling, and it snowballed. Maybe this guy started it all with his spoofing and then selling. But, unless you prove he somehow set out to try to cause the whole thing so he could exploit it for massive profit, or found some illegal loophole to tip over the whole system, I'm not sure what they're going to ultimately nab him on. Who knows, maybe the Securities and Exchange Commission (SEC) tried to extract some money and he's balked, and they finally had to charge him with something. And, there are other questions:

Yes and yes -- or so it would seem. Now, we don't know actually if there was a margin violation. Hey, the guy was minting coin, maybe he had enough in there to stay within margin rules. Theoretically, no system should allow you to enter a gigantic "spoof" order if the capital required exceeds your account size. The trading system shouldn't know the guy's algo will prevent order execution. So, I'll give the broker a pass, again assuming we don't find out they gave him some sort of unusual accommodations.

The CME Group and the regulatory bodies, though? They allowed this sort of behavior. They still allow similar behavior. Again, it feels like they're punishing a guy for exploiting a structure they permitted. If we can prove malice on the trader's part, that's different, but we need to see that.

I don't mean to imply I'm giving the guy a pass. At best he recklessly endangered the financial markets. But, it strikes me as finding a scapegoat for something that was clearly an accident waiting to happen.

Disclaimer: Mr. Warner's opinions expressed above do not necessarily represent the views of Schaeffer's Investment Research.


Target Effortless Triple-Digit Gains Every Sunday Evening For Life!

This is your chance to triple your profit potential on Sunday evenings, without spending all your free time watching the market.

On Sundays, as a Weekend Plus subscriber, you’ll get up to 6 trades every Sunday, each targeting gains of 200% or more.

Start targeting gains like the ones our subscribers have seen recently, including:

213.3% GAIN on AutoNation calls
100.0% GAIN on Monster Beverage calls
100.4% GAIN on Walgreens Boots Alliance puts
100.4% GAIN on ON Semiconductor calls
257.7% GAIN on Dell calls

101.0% GAIN on Apollo Global Management calls
103.6% GAIN on JP Morgan  Chase calls
105.3% GAIN on DraftKings calls
101.3% GAIN on Airbnb calls
203.0% GAIN on Shopify calls
102.0% GAIN on Cboe Global Markets calls
100.9% GAIN on Boeing calls
102.1% GAIN on Microsoft puts
102.3% GAIN on First Solar calls
101.5% GAIN on PulteGroup calls
101.0% GAIN on Apple calls
209.4% GAIN on NXP Semiconductors calls
100.8% GAIN on Uber Technologies calls
100.4% GAIN on Academy Sports and Outdoors puts
102.2% GAIN on Trade Desk calls
100.8% GAIN on DoorDash calls
100.0% GAIN on Camping World Holdings puts
100.0% GAIN on Cboe Global Markets calls
100.2% GAIN on C3.ai calls
238.5% GAIN on Oracle calls



Rainmaker Ads CGI