Meet The Man Who Flash-Crashed The Stock Market From His Bedroom

It's funny how one person's seemingly small actions from his bedroom can result in an event with international news coverage. This was the case with the infamous 2010 Flash Crash that sent shockwaves to the stock market, even for only about 36 minutes.

The most amazing thing about this crash is the instigator behind it was a little-known UK-Indian trader. This is the story of Navinder Singh Sarao, the 'Hound of Hounslow,' who'll forever be known as the man who cheated Wall Street from a bedroom in his parents' home.

(Check out this great doccie by Bloomberg on this story here).

Who is Navinder Singh Sarao?

Navinder is a London-based futures trader born on 14 November 1978 who started trading in 2002. Sarao had Asperger's, making him autistic. This made him socially awkward and vulnerable to deception.

On the bright side, people with Asperger's may be geniuses who can obsess over a single subject until they master it. Those around Sarao considered him a math savant in school who ended up studying computer science at Brunel University in London.

Even the Futex chairman at the time, Paolo Rossi, said in a Bloomberg TV interview that he'd "be remembered as one of the world's greatest traders." Yet, only in 2008, when he left Futex, did he start making a fortune. Filings of his company, Nav Sarao Futures Ltd, showed his assets were worth £14.9 million by the end of June 2009.

But this was only the beginning. This time, with the help of a programmer, he built a trading program that gave him a market manipulation 'cheat code.'

This software practised 'spoofing.' Here, it would place tons of limit orders to create artificial supply or demand. The software would then cancel them soon after when the price was nearby them and take the opposite trade.

It's an effective way to make profits because you can sell at a higher price or buy at a lower price than normal. Between 2009 and 2014, reports suggest that Nav made about $70 million from spoofing.

Sarao's primary market was the E-mini S&P 500 futures through the Chicago Mercantile Exchange (CME).

The fateful day

Sarao wasn't the sole contributor to the flash crash on 06 May 2010 but played a significant role. The ripple effect of several large orders from him and other institutions produced the outcome.

The day was going fine until a few hours before 14h32 ET. Nav began spoofing E-mini S&P futures with six sell orders worth $200 million. Regulators also found that Sarao modified these orders 19 000 times and that they represented between 20-29% of the sell side.

When 14h32 ET hit, an institution, later discovered as the US mutual fund Waddell & Reed, sold 75 000 E-mini contracts valued at $4.1 billion. This, combined with Nav's spoofing, negative market sentiment and other automated trading programs, was enough to send several stock indices plummeting by a record-breaking 9%.

The affected markets include the NASDAQ Composite, the Dow Jones Industrial Average (DJIA) and, of course, the S&P 500. Below is a picture of what the DJIA looked like on the charts with the crash

Billions were made and lost during this crash, which lasted roughly 36 minutes. As expected, when the prices recovered, Sarao reportedly profited $879,018 thanks to his spoofing. This was a historic yet turbulent day in the financial markets.

The aftermath

Investigators put forward many theories, like the 'fat finger' and technical glitches on the day of the crash. Yet, the common denominator was always automated or high-frequency trading (HFT).

The first breakthrough came on 30 September 2010 with a lengthy report from the SEC (Securities and Exchange Commission) and the CFTC (Commodity Futures Trading Commission). "Findings Regarding the Market Events of May 6, 2010," detailed the trail leading to the crash.

Yet, it did not mention potential manipulation or a lone trader like Sarao having an impact. Meanwhile, he continued 'spoofing away', despite several warnings from his exchange, who knew they were cheating.

So, how was Nav linked to the 2010 flash crash? It was an unnamed day trader from Chicago who blew the whistle. While back-testing his trading system, he studied the weird orders placed that day and informed the CFTC.

They further analysed the data with their expertise, concluding that Sarao's positions were part of the cause of the crash. Afterwards, the CFTC got involved Department of Justice (DoJ), which got an arrest warrant for Nav.

In February 2015, half a dozen police officers, two DoJ prosecutors and two FBI agents flew to London to detain him. He only had his bail hearing at the Westminster Magistrates Court on 22 April 2015.

The DoJ charged him with 22 criminal counts of wire fraud, spoofing and market manipulation. Furthermore, the court granted him conditional bail of £5.05 million. Yet, this turned out to be too hefty for Nav after those around him discovered his wealth was tied to numerous investment and offshore trusts.

In short, he didn't have the money, and the US authorities froze his assets. This meant that he had to go to prison, a Victorian-esque jail named HMP Wandsworth in London. After spending four months there, Nav's legal team negotiated with the US authorities to reduce his bail to £50,000.

This was possible as they argued that the earlier bail was illegal due to the freezing of Sarao's assets. The loophole worked like a charm, leading to the release of Nav. His bail conditions included abiding by a nightly curfew, handing in his passport and, of course, not using the internet for trading.

It was only in January 2020 that the US authorities finalised the case where Nav pleaded guilty to one count of electronic fraud and one for spoofing. Luckily, the punishment was only a year of house arrest, which was only lenient because of his generous cooperation.

Final thoughts: criminal mastermind or sacrificial lamb?

Those in Nav's court hearings say that Nav asserted he didn't do "anything wrong apart from being good at my job." He was a highly frugal man who saw the markets as a "sophisticated video game" to collect points, not money.

To many traders worldwide, Nav became a 'folk hero' who made a fortune fighting against Wall Street supremacy. He believed his actions were right in an environment of 'rigged' markets, which regulators have sometimes failed to police.

Also, Sarao's involvement in the crash remains debatable. Many feel he became a scapegoat for manipulative tactics that well-connected and monied entities had long practised before him.

In the words of the late Roy Bennett, “What one thinks is right is not always the same as what others think is right; no one can always be right.”