brrrr spoofingYeah, they got him. The guy who single handedly caused the markets to crash, armed with his excel sheet and some spoofing algo’s. Most people in the market are sceptic.  This post by Adrian Ip is one of the best reactions I’ve read. Everything below is written by Adrian (who works for Thomson Reuters). Original source is here.

I was pretty surprised this morning to read about the arrest of a London based futures trader for allegedly causing the infamous flash crash of 2010. I immediately downloaded the publicly available criminal complaint to have a read of the detail (available here).

For those that don’t know, this type of stuff holds a special interest for me as prior to TR I worked for companies selling, designing, building and supporting highly automated low latency derivatives trading systems (yes, I know, I’m the devil), which we licensed to companies to trade with. I’ve got many years experience in investigating strange market patterns and designing systems and algos to both combat and take advantage of these conditions so I have some understanding of the situation.

A few things stand out to me on initial reading of the news stories and the criminal complaint itself:

  • A lot of this seems focussed on the fact that Sarao had a system which automatically placed buy and sell orders at varying price points in given contracts (layering).
  • There is also mention of spoofing which takes many different forms but ultimately means an order being placed with no intention of actually executing. Difficult to prove since there are so many reasons you may want to have a system change or cancel an order under so many different circumstances.
  • Activities such as layering and spoofing are standard procedure to a certain extent and the definitions vary.
  • Trading systems automatically moving prices you have in the market is nothing new or bad.


Honestly, I don’t get what the big deal is. Layering is an EXTREMELY common activity in the market. Imagine you’re a market maker. It’s your job to provide liquidity to the market. You make your money by taking the tiny spread between people who want to buy from you and those who want to sell to you. You’re probably making markets in more than one instrument or underlying because the amount of money you make from each lot that you buy or sell is small. In traditional terms, it’s the stack ’em high, sell ’em cheap approach and you’re not a long term positional research based trader so you aren’t up on all the latest news and rumours regarding all the companies you quote.

Now, what happens if somebody out there is trying to build up a large position in something you quote? Maybe they want to buy a few hundred shares and that’s not a big deal, but what if they want thousands? Hundreds of thousands? Millions even? Chances are they have a better idea than you where the market is heading. If they’re looking to buy so much, maybe the value is higher than you know? Wouldn’t you want to be wary about selling so much of something when normally you only trade a few thousand lots? This is a typical defensive strategy employed in the markets to deal with such scenarios. Nobody knows everything, you need to protect yourself for when someone perhaps knows something material which you don’t, as such, you layer your prices.

People who quote extremely tight spreads take the most risk that the price they have posted is out of date and they’ll lose money, this is why the majority of volume in a given contract is available at prices worse than the best bid or offer (BBO). It’s also why people use automated trading programs to shift their prices when the market moves as a slow trader won’t be a trader for long as they’ll lose all their money.

The criminal filing is odd. Page 21 of the document states “SARAO’s Manipulative Activity Contributed to the Flash Crash” and then goes on to describe trading activity which thousands of firms employ globally on a daily basis. It’s no secret that market makers, hft, algo traders etc benefit from volatility and I know other companies also made a lot of money on that day. It doesn’t mean they were illegally attempting to manipulate the markets. Automated systems have so many capabilities to do things, sometimes they do stuff intentionally, sometimes not, just look at Knight as a perfect example of an algo gone wild costing a firm almost half a billion.

Really I’m surprised that they’re looking to pin the flash crash on one person. I remember years ago having a conversation with one of my old CTO’s and remarking that the system we were building was one which would one day contribute to a global financial meltdown and he agreed. Perhaps Sarao did contribute to the flash crash, but so too did a hell of a lot of others. The focus should be on creating a better system, not on looking for a scapegoat. I’ll be following the case with interest.