Citation record for Incident 28

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Anonymous. (2010-05-08) Incident Number 28. in McGregor, S. (ed.) Artificial Intelligence Incident Database. Partnership on AI. Retrieved on November 27, 2021 from

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Full Description

On May 6, 2010, the New York Stock Exchange and US Down Jones were greatly impacted by highly volatile trading at high volumes. The blame fell on a single trader in the UK, Navinder Singh Saroa, who allegedly modified a trading algorithm to allow him to mislead the market. Saroa would place requests to purchase stocks (establishing interest in the stock and driving the price higher) but cancel the transaction before it was carried out. Reports say that within minutes major stocks such as General Electric and Accentre had hit $0, and the overall market dropped by 6%. Around $1 trillion in paper stocks had seemingly been wiped out. He faces 22 charges in the US.

Short Description

A modified algorithm was able to cause dramatic price volatility and disrupted trading in the US stock exchange.



Harm Type

Financial harm

AI System Description

A stock trading algorithm designed to quickly detect shifts in stock prices and execute trades accordingly.

Sector of Deployment

Financial and insurance activities

Relevant AI functions

Perception, Cognition, Action

AI Techniques

stock market algorithm; machine learning

AI Applications

stock trading



Named Entities

Navinder Singh Saroa, Dow Jones Industrial Index, Chicago Merchant Exchange

Technology Purveyor

Navinder Singh Sarao

Beginning Date


Ending Date


Near Miss

Harm caused


Deliberate or expected

Lives Lost


Infrastructure Sectors

Financial services

Financial Cost

Short term: $1 trillion unclear of long-term impact

Laws Implicated


Data Inputs

Stock Price; trading volume

Incidents Reports

2010 Flash Crash · 2010

The DJIA on May 6, 2010 (11:00 AM - 4:00 PM EDT)

The May 6, 2010, Flash Crash,[1][2] also known as the Crash of 2:45, the 2010 Flash Crash or simply the Flash Crash, was a United States trillion-dollar[3] stock market crash, which started at 2:32 p.m. EDT and lasted for approximately 36 minutes.[4]:1 Stock indices, such as the S&P 500, Dow Jones Industrial Average and Nasdaq Composite, collapsed and rebounded very rapidly.[4] The Dow Jones Industrial Average had its second biggest intraday point drop (from the opening) up to that point,[4] plunging 998.5 points (about 9%), most within minutes, only to recover a large part of the loss.[5][6] It was also the second-largest intraday point swing (difference between intraday high and intraday low) up to that point, at 1,010.14 points.[4][5][7][8] The prices of stocks, stock index futures, options and exchange-traded funds (ETFs) were volatile, thus trading volume spiked.[4]:3 A CFTC 2014 report described it as one of the most turbulent periods in the history of financial markets.[4]:1

When new regulations put in place following the 2010 Flash Crash[9] proved to be inadequate to protect investors in the August 24, 2015 flash crash—"when the price of many ETFs appeared to come unhinged from their underlying value"[9]—ETFs were put under greater scrutiny by regulators and investors.[9]

On April 21, 2015, nearly five years after the incident, the U.S. Department of Justice laid "22 criminal counts, including fraud and market manipulation"[10] against Navinder Singh Sarao, a trader. Among the charges included was the use of spoofing algorithms; just prior to the Flash Crash, he placed thousands of E-mini S&P 500 stock index futures contracts which he planned on canceling later.[10] These orders amounting to about "$200 million worth of bets that the market would fall" were "replaced or modified 19,000 times" before they were canceled.[10] Spoofing, layering, and front running are now banned.[3]

The Commodity Futures Trading Commission (CFTC) investigation concluded that Sarao "was at least significantly responsible for the order imbalances" in the derivatives market which affected stock markets and exacerbated the flash crash.[10] Sarao began his alleged market manipulation in 2009 with commercially available trading software whose code he modified "so he could rapidly place and cancel orders automatically."[10] Traders Magazine journalist, John Bates, argued that blaming a 36-year-old small-time trader who worked from his parents' modest stucco house in suburban west London[10] for sparking a trillion-dollar stock market crash is a little bit like blaming lightning for starting a fire" and that the investigation was lengthened because regulators used "bicycles to try and catch Ferraris." Furthermore, he concluded that by April 2015, traders can still manipulate and impact markets in spite of regulators and banks' new, improved monitoring of automated trade systems.[3]

As recently as May 2014, a CFTC report concluded that high-frequency traders "did not cause the Flash Crash, but contributed to it by demanding immediacy ahead of other market participants."[4]:1

Some recent peer-reviewed research shows that flash crashes are not isolated occurrences, but have occurred quite often. Gao and Mizrach studied US equities over the period of 1993–2011. They show that breakdowns in market quality (such as flash crashes) have occurred in every year they examined and that, apart from the financial crisis, such problems have declined since the introduction of Reg NMS. They also show that 2010, while infamous for the Flash Crash, was not a year with an inordinate number of breakdowns in market quality.[11]

Background [ edit ]

On May 6, 2010, U.S. stock markets opened and the Dow was down, and trended that way for most of the day on worries about the debt crisis in Greece. At 2:42 p.m., with the Dow down more than 300 points for the day, the equity market began to fall rapidly, dropping an additional 600 points in 5 minutes for a loss of nearly 1,000 points for the day by 2:47 p.m. Twenty minutes later, by 3:07 p.m., the market had regained most of the 600-point drop.[12]:1

At the time of the Flash Crash, in May 2010, high-frequency traders were taking advantage of unintended consequences of the consolidation of the U.S. financial regulations into Regulation NMS,[3][13] designed to modernize and strengthen the United States National Market System for equity securities.[14]:641 The Reg NMS, promulgated and described by the United States Securities and Exchange Commission, was intended to assure that investors received the best price executions for their orders by encouraging competition in the marketplace, created attractive new opportunities for high-frequency-traders. Activities such as spoofing, layering and front-running were banned by 2015.[citation needed] This rule was designed to give investors the best possible price when dealing in stocks, even if that price was not on th...

2010 Flash Crash
The 2010 Flash Crash: What Caused It and How to Prevent the Next One · 2010

Fragmentation among stock exchanges . In 1987, when we had the crash that took 22.6% off the Dow, trading execution was much slower and more concentrated. Back then, 90% of stock trading occurred on the New York Stock Exchange (NYSE). In 2004, Regulation NMS changed all that -- encouraging the emergence of new electronic exchanges like BATS and DirectEdge. By 2010, a mere 15% to 17% of all NYSE trades were controlled by the NYSE (the new electronic exchanges controlled the rest).

. In 1987, when we had the crash that took 22.6% off the Dow, trading execution was much slower and more concentrated. Back then, 90% of stock trading occurred on the New York Stock Exchange (NYSE). In 2004, Regulation NMS changed all that -- encouraging the emergence of new electronic exchanges like BATS and DirectEdge. By 2010, a mere 15% to 17% of all NYSE trades were controlled by the NYSE (the new electronic exchanges controlled the rest). Different ways of trading with exchanges that go into so-called slow mode . These new exchanges had different ways of handling big ups and downs in the market. The NYSE preserved a way to put people in charge -- and take control away from the computers -- in the event of a big percent change in a stock's price. Putting a person in charge of trading a stock was called slow-mode. Some of the new electronic exchanges had rules that caused them to stop trading with exchanges that went into slow mode. This led different exchanges to quote very different prices for a specific stock.

. These new exchanges had different ways of handling big ups and downs in the market. The NYSE preserved a way to put people in charge -- and take control away from the computers -- in the event of a big percent change in a stock's price. Putting a person in charge of trading a stock was called slow-mode. Some of the new electronic exchanges had rules that caused them to stop trading with exchanges that went into slow mode. This led different exchanges to quote very different prices for a specific stock. Inconsistent rules for handling bad price information. These different prices caused some market participants to lose confidence in the price information they were getting from the markets. And these participants' computers were programmed to shut down and stop trading in the event that they received bad or mis-information.

Agree on a standard definition of an erroneous trade . As noted above, not all participants agree on what constitutes an erroneous trade. Some would argue that if there is no demand for a stock at $40 and the only way to execute the sale is to cut the price to six cents, that's fine. Others would call that an erroneous trade. iShares believes that all exchanges must agree on a standard definition to stop the next flash crash. And they must then agree on how to cancel and communicate such an erroneous trade.

. As noted above, not all participants agree on what constitutes an erroneous trade. Some would argue that if there is no demand for a stock at $40 and the only way to execute the sale is to cut the price to six cents, that's fine. Others would call that an erroneous trade. iShares believes that all exchanges must agree on a standard definition to stop the next flash crash. And they must then agree on how to cancel and communicate such an erroneous trade. Create standard ways for exchanges to deal with an exchange that goes into slow mode . During the flash crash, some electronic exchanges refused to deal with an exchange that decided to go into slow mode. Instead, they went on to trade with other exchanges that continued to operate in regular mode. iShares believes that all exchanges need to have standard rules for ignoring what Clements called "a pool of liquidity," such as the NYSE or any other exchange that goes into slow mode.

. During the flash crash, some electronic exchanges refused to deal with an exchange that decided to go into slow mode. Instead, they went on to trade with other exchanges that continued to operate in regular mode. iShares believes that all exchanges need to have standard rules for ignoring what Clements called "a pool of liquidity," such as the NYSE or any other exchange that goes into slow mode. Boost transparency of market makers' obligations and incentives. Finally,iShares wants the SEC to define the obligations of so-called Designated Market Makers (DMMs), such as the people on the NYSE who seek to create an orderly market in stocks like Accenture. Specifically, iShares wants to make it clear that DMMs have an obligation to keep a stock's price from collapsing and create incentives for them to step in and buy when there are no other buyers to keep the price from collapsing.

Remember the flash crash? That was the 20 minutes on May 6, 2010 when the Dow lost almost 1,000 points before partially recovering. Most investors have forgotten about it. But not iShares, the Blackrock ( BLK ) subsidiary that accounts for 50% of trading in exchange-traded funds (ETFs). iShares...

The 2010 Flash Crash: What Caused It and How to Prevent the Next One
Findings Regarding the Market Events of May 6, 2010 · 2010

On May 6, 2010, the prices of many U.S.-based equity products experienced an extraordinarily rapid decline and recovery. That afternoon, major equity indices in both the futures and securities markets, each already down over 4% from their prior-day close, suddenly plummeted a further 5-6% in a matter of minutes before rebounding almost as quickly.

Many of the almost 8,000 individual equity securities and exchange traded funds (“ETFs”) traded that day suffered similar price declines and reversals within a short period of time, falling 5%, 10% or even 15% before recovering most, if not all, of their losses. However, some equities experienced even more severe price moves, both up and down. Over 20,000 trades across more than 300 securities were executed at prices more than 60% away from their values just moments before. Moreover, many of these trades were executed at prices of a penny or less, or as high as $100,000, before prices of those securities returned to their “pre-crash” levels.

By the end of the day, major futures and equities indices “recovered” to close at losses of about 3% from the prior day....

Findings Regarding the Market Events of May 6, 2010
What Really Caused the Flash Crash · 2011

Here's the basic outline of what caused the biggest one-day point decline in the history of the Dow Jones Industrial Average. On May 6, 2010, the primary market makers in the stock market just stopped automatically taking the other side of everyone else's trades. This made the market extremely illiquid. Sell orders had no immediate bids, which basically meant the market became a bottomless pit for a few minutes.

A brief historymight help to explain this. In the old days, important stocks were monitored by so-called "specialists" who worked on the trading floors of the stock exchanges. They were charged with keeping the market "orderly." This meant they would temporarily take the other side of trades when unmatched orders to buy or sell came in.

The government hated these guys. It was constantly accusing them of cheating investors in one way or another. The policy makers did everything they could to wipe out the specialists, replacing them with computers.

As a result of the government's war on specialists, much of liquidity in the market now comes from high-frequency trading computers. Let's call them High Freaks. These things can execute trades at the speed of light.

Mainly, they make money by executing an enormous volume of trades around small price points. You sell for one dollar, they buy for a dollar and one tenth of a cent. They they sell for a dollar and two tenths of a cent. Do that often enough and you're talking real money....

What Really Caused the Flash Crash
The 2010 'flash crash': how it unfolded · 2012

In just 20 minutes the New York Stock Exchange had witnessed it’s biggest stock plunge in decades, all traced to one gargantuan sell order

It was 6 May 2010. In the UK it was general election day, in the US,Wall Street was gripped by mounting anxiety about the Greek debt crisis. The euro was falling against the dollar and the yen, but despite the turbulent start to the trading day, no one had expected the near 1,000-point dive in share prices.

In a matter of minutes the Dow Jones index lost almost 9% of its value – in a sequences of events that quickly became known as “flash crash” . Hundreds of billions of dollars were wiped off the share prices of household name companies like Proctor & Gamble and General Electric. But the carnage , which took place at a speed never before witnessed, did not last long. The market rapidly regained its composure and eventually closed 3% lower.

'Flash crash' case: UK trader to fight extradition to US Read more

There was a frenzy of speculation about what might have caused the rout, with explanations ranging from fat fingered trading to a cyberattack. But within days, officials in the US were blaming big bets by a trader on Chicago’s derivatives exchange. By the end of September, an official report by the two main US regulators pointed to a $4.1bn (£2.7bn) sell order instigated by a US mutual fund, said to be Waddell & Reed.

At 2.32 pm, the mutual fund had used an automated algorithm trading strategy to sell contracts known as e-minis. It was the largest change in the daily position of any investor so far that year and sparked selling by other traders, including high frequency traders.

The official report by the Securities and Exchange Commission and the Commodity Futures Trading Commission outlined a “hot potato” effect as the HFTs started and buying and then reselling the e-mini contracts. Some orders were executed at “irrational prices” as low as one penny or as high as $100,000 before the share prices returned to their pre-crash levels by 3pm. In just 20 minutes, 2bn shares worth $56bn had changed hands....

The 2010 'flash crash': how it unfolded
The lasting impact of the 2010 flash crash · 2014

The Dow Jones Industrial Average slumped nearly 1,000 points in a matter of minutes in the flash crash of 2010, sending traders into a panic and inciting scrutiny of the U.S. equities markets that's still being felt four years later.

The May 6, 2010, crash was initially blamed on a "fat-finger" error made at Citigroup—a theory that was later shot down and ultimately attributed to investment firm Waddell & Reed. But in addition to that trading error, a number of possible reasons for the crash has since come to light. One of those supposed causes was high-frequency trading, according to a report from the Securities and Exchange Commission that year....

The lasting impact of the 2010 flash crash
Guy Trading at Home Caused the Flash Crash · 2015

Hey look, they caught the guy who caused the flash crash of 2010! His name is Navinder Singh Sarao, and he lives in London and in 2009 he asked someone to help him build a spoofing robot:

On or about June 12, 2009, SARAO sent an email to a representative of his FCM in which he explained that he "need[ed] to get in touch with a [] technician [at the company that provided his trading software ("Trading Software Company #1")] that will be able to programme for me extra features on [the software]," namely, "a cancel if close function, so that an order is canceled if the market gets close."

Sarao was trading E-mini S&P 500 futures contracts, but he wanted a more convenient way to "not to trade them", so he e-mailed his FCM (futures commission merchant, i.e. broker) for help automating that. The idea is that he would put in a big order to sell a whole bunch of futures at a price a few ticks higher than the best offer. So probably he wouldn't sell any futures, since he wasn't offering the best price. But he had to keep constantly updating his orders to keep them a few ticks higher than the best offer, to make sure that he didn't accidentally sell any futures as the market moved. And that's a bit of a pain, so he programmed an algorithm to do it for him. Though he also seems to have done similar things manually, to support the algorithm's efforts, or to stave off boredom while the algorithm did its thing.

The point of this -- according to the federal prosecutors, the Federal Bureau of Investigation and the Commodity Futures Trading Commission, who are not happy with Sarao -- is that by placing all these fake sell orders, Sarao would artificially drive down the price of the E-mini futures. It's classic spoofing: He'd place a lot of big orders to sell, everyone else would say, "Ooh look at all those big sell orders, I'd better sell too," they'd sell, the market would go down, he'd buy, he'd turn off his algorithm, everyone else would say, "Oh hey never mind, things are great again, there are no more big sell orders," they'd buy, the price would go back up, and Sarao would sell the futures he'd bought at a lower price a moment ago. We've talked about spoofing before, and I've always been a little troubled that it works, but what can I say, it works.

On May 6, 2010, according to the authorities, it worked a little too well: Sarao did such a good job of driving down the price of the E-mini future that he caused a flash crash in which "investors saw nearly $1 trillion of value erased from U.S. stocks in just minutes."

I'll put some more details downstairs but honestly they are boring details. Sarao traded a ton of E-mini futures during the flash crash -- "62,077 E-mini S&P contracts with a notional value of $3.5 billion" -- and made "approximately $879,018 in net profits" that day, or a profit of about 2.5 basis points on the notional amount, which I guess isn't bad for one day's work. He did this by, basically, putting in orders to sell thousands of contracts away from the best offer. Those orders were never executed, or intended to be executed, but they tricked people into thinking that there was a lot more selling interest than there actually was. That combined with a collapse in buying interest -- at one point Sarao's fake sell orders alone "were almost equal to the entire buyside of the Order Book" -- to create a collapse in prices. He profited from those collapsing prices by selling high and buying back lower. It's a pretty straightforward spoofing story.

So straightforward that one of the biggest puzzles here is why it took so long -- and the help of a whistleblower -- for regulators to figure it out. They came tantalizingly close:

As reflected in correspondence with both SARAO and an FCM he used, the CME observed that, between September 2008 and October 2009, SARAO had engaged in pre-opening activity -- specifically, entering orders and then canceling them -- that "appeared to have a significant impact on the Indicative Opening Price." The CME contacted SARAO about this activity in March 2009 and notified him, via correspondence dated May 6, 2010, that "all orders entered on Globex during the pre-opening are expected to be entered in good faith for the purpose of executing bona fide transactions." The CME provided a copy of the latter correspondence to SARAO's FCM, which suggested to SARAO in an email that he call the FCM's compliance department if he had any questions. In a responsive email dated May 25, 2010, SARAO wrote to his FCM that he had "just called" the CME "and told em to kiss my ass."

Emphasis added because come on: The futures exchange wrote to Sarao on the day of the flash crash, telling him to stop spoofing, and he called them back "and told em to kiss my ass." And then regulators pondered that reply for five years before deciding that they'd prefer to have him arrested in London and extradited to face criminal spoofing charges. One conclusion here might be that rudeness to regulators really works.

Even odder, Sarao didn't just retire to a supervillain lair after the flash crash. The CFTC lists "at least" 12 days on which he allegedly manipulated the futures market; eight of them came after the flash crash, and he allegedly continued to manipulate the futures market more or less up to the moment he was arrested. 5 The CFTC claims that Sarao basically started his spoofing career by causing the flash crash, and then went ahead and kept spoofing for another five years without much interruption. I guess he got more subtle at it? Not very subtle though; he was a consistently large trader, "placing, repeatedly modifying, and ultimately canceling multiple 200-, 250-, 300-, 400-, 500-, 550-, 600-, and 900-lot sell orders," versus an average order size of seven contracts. He also seems to have had some patterns (like putting in orders for exactly 188 or 289 contracts that never executed) that you'd think would make him easier for regulators or exchanges to spot. If regulators think that Sarao's behavior on May 6, 2010, caused the flash crash, and if they think he continued that behavior for much of the subsequent five years, and if that behavior was screamingly obvious, maybe they should have stopped him a little earlier?

Also, I mean, if his behavior on May 6, 2010, caused the flash crash, and if he continued it for much of the subsequent five years, why didn't he cause, you know, a dozen flash crashes?...

Guy Trading at Home Caused the Flash Crash
What happened during the Flash Crash? · 2015

On Thursday May 6, 2010, the US stock market collapsed , wiping billions off some of the world's biggest companies.

The Dow Jones Industrial Average, already down more than 4pc from the previous day's close, plummeted a further 5pc to 6pc in a matter of minutes before recovering almost as quickly. However, the index still closed nearly 350 points lower.

Around 8,000 individual shares and exchange traded funds suffered price declines and subsequent rebounds. Many of those shares fell by as much as 15pc before recovering later in the day.

Just hours later, European markets opened and followed suit. The UK's FTSE 100 fell 138 points, France's Cac shed 163 points, and Germany's Dax dropped 193 points. Then the Dow opened again, and subsequently lost a further 139 points.

The so-called "flash crash" occured during the depths of the financial crisis, when rumours were rife that Greece would default on its debt and be forced to exit the eurozone.

Amid this uncertainty, the US Commodity Futures Trading Commission alleged that Navinder Singh Sarao, a futures trader based in the UK, and Nav Sarao Futures Limited manipulated the E-mini S&P 500, a futures index based on the S&P 500 - an index of 500 companies designed to be a leading indicator of US equities that features such firms as Amazon, Boeing and Bank of America.

Essentially, this means Sarao allegedly agreed to sell assets for a set price, with payment occurring at a future point, but never intended to complete the transactions.

The CFTC has charged Sarao with unlawfully manipulating, attempting to manipulate, and spoofing (placing orders to buy or sell an asset without the intention of completing the deal, and then cancelling it) — all with regard to the E-mini S&P 500.

The CFTC claims that Sarao, using a computer algorithm, placed large orders to sell E-mini S&P 500 stocks with no intention of ever completing the agreements. These orders were priced competitively, so as not to stand out and attract attention as being unusually high or low, the CFTC said.

"By allegedly placing multiple, simultaneous, large-volume sell orders at different price points - a technique known as 'layering' - Sarao created the appearance of substantial supply in the market," the Department of Justice said.

Sarao then allegedly traded in other shares that would profit from the large market movements that his fraudulent orders created, the CFTC said.

The charges against Sarao

In its report on the events of May 6, the CFTC and SEC stated: "At 2:32pm, against [a] backdrop of unusually high volatility and thinning liquidity, a large fundamental trader initiated a sell program to sell a total of 75,000 E-mini contracts (valued at approximately $4.1bn) as a hedge to an existing equity position."

The trader then executed the sell program "extremely rapidly in just 20 minutes", causing the largest net change in daily position of any trader in the E-mini since the beginning of the year.

This pressure drove the price of the E-Mini down by around 3pc in just four minutes. As prices fell, buying on the E-mini dried up, creating a “hot-potato” effect as the same equity positions were rapidly passed back and forth between traders.

By this point, buy-side liquidity in the E-mini had fallen from its early-morning level of nearly $6bn to $2.65bn - a 55pc decline.

Navinder Singh Sarao

With a lack of buyers, prices continued to fall, hitting intraday lows of -10pc. At 2:45pm, market conditions triggered a "Stop Logic Functionality" - a pause in the market allowing participants to inject more money and stabilise the index.

Despite extreme price fluctuations that saw prices as low as one penny or as high as $100,000, the Stop Logic Functionality succeeded, and most securities "reverted back to trading at prices reflecting true consensus values", the report stated.

The program continued to trade until about 2:51pm, the CFTC said, with normal market trading resuming at about 3pm.

The CFTC claimed Sarao made $40m from his alleged scheme between April 2010 and April 2015....

What happened during the Flash Crash?
Trader Arrested in Manipulation That Contributed to 2010 ‘Flash Crash’ · 2015

Five years ago, the global financial system was rocked by the “flash crash,” 15 minutes of chaos that shook the world’s biggest markets and prompted investors both big and small to question how such a vital part of the economy could be brought to its knees.

On Tuesday, United States prosecutors said that much of the blame for the event could be pinned on a single person: a 36-year-old man who had been boldly manipulating markets from his suburban rowhouse just a few minutes from Heathrow Airport outside London, where he was arrested.

Regulators said that their prosecution of the trader, Navinder Singh Sarao, demonstrated their aggressiveness in rooting out market manipulation. But news of the arrest, if anything, has raised anew concerns about how an individual could manage to exert such influence over the world’s financial markets. The case also played into worries that have swirled around the increasingly automated and complex financial markets, where regulators have struggled to keep up with nimble new participants like high-frequency trading firms that use sophisticated networks to make money in milliseconds via rapid-fire trades.

For the latest case, it took the authorities five years to track down a rogue actor making enormous trades. And, they were led to him only with the help of an outside whistle-blower....

Trader Arrested in Manipulation That Contributed to 2010 ‘Flash Crash’
The 2010 ‘flash crash’ now has a criminal suspect · 2015

Fox Business Was one trader responsible for the flash crash?

WASHINGTON (MarketWatch) — The 2010 “flash crash” — in which the Dow industrials sank by around 1,000 points before quickly recovering — has been debated for years. But on Tuesday the U.S. for the first time filed a criminal charge relating to it.

The Justice Department on Tuesday unsealed charges, and sought extradition, of a Brit who conducted day trading in futures contracts from his London home. The Commodity Futures Trading Commission also filed civil charges against Navinder Singh Sarao and his company.

A law firm says a whistleblower unearthed the allegations.

Our anon. client brought powerful,original analysis to CFTC after 100s of hours investigating #FlashCrash for years — Whistleblower Law (@WhistleblowerHB) April 21, 2015

Sarao was arrested in the U.K. over the charges relating to manipulation. While the government has alleged manipulation on at least 10 different occasions, it is the activity of May 6, 2010, that will draw the most attention.

The U.S. government says Sarao was engaged in what’s called layering, which involves making multiple, bogus orders that are quickly canceled to trick other market participants. Sarao used the E-mini S&P 500 contract to conduct spoofing, the court document says.

On the day of the flash crash, Sarao modified more than 20 million lots — compared with the fewer than 19 million lots the rest of the market modified, the U.S. alleges.

Sarao allegedly used “dynamic layering” between 11:17 a.m. and 1:40 p.m. Central time, and created persistent downward pressure on the price of the E-minis. His offers composed 20% to 29% of the CME’s entire E-mini sell-side order book, the U.S. alleges. Sarao made $879,018 in profits that day, and nearly $9 million on the trading days where the U.S. alleged illegal activity, and around $40 million over four years.

On social media, he was mocked both for soliciting outside help to create software and for the relatively small size of his profits relative to the disturbance he allegedly caused.

@ThemisSal @JaffrayW Even more sad...he only made $867k when the mkt declined over $1T in value...rookie — Kimberly Scott (@hikergal23) April 21, 2015

His colorful language also was noted — according to an email, he told the Chicago Mercantile Exchange CME, +1.40% “to kiss my ass” after being questioned over his entering and then canceling orders. At another point, Sarao characterized his own trading as just demonstrating to a friend “what occurs on the bid side of the market almost 24 hours a day, by the high frequency geeks,” according to the Justice Department description of his email.

As for the flash crash, the CFTC and the Securities and Exchange Commission stated in their joint report that E-mini trading spilled over into the equity market and helped trigger the extreme movements. But the E-mini trades that the agencies said triggered the big moves were from a large trader, subsequently identified as Waddell & Reed. Waddell & Reed has always maintained that their trades were not out of the ordinary.

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The 2010 ‘flash crash’ now has a criminal suspect
The great flash crash of 2010: What happened to the Dow Jones and what is Navinder Singh Sarao supposed to have done? · 2015

Jessica Morris

The "flash crash" caused the Dow to fall as much as nine per cent (Source: Getty)

British trader Navinder Singh Sarao has been arrested, charged and is facing extradition to the United States over his role in the "flash crash". Sarao has appeared before Westminster Magistrates and has said he will contest this.

It started in the early afternoon of 6 May 2010, as panicked investors watched the Dow Jones Industrial Average plunge around nine per cent in a matter of seconds. And the most terrifying thing was nobody really knew why.

The Dow had recovered a large part of its losses by the time markets closed. However, the 1,000 point dive is still the index's second-largest point swing, and its biggest one-day intra-day decline ever.

Some stocks suffered huge price swings, with the share prices of two companies in particular - Procter & Gamble and 3M - falling 36 per cent and 18 per cent respectively.

So what happened on the day of the "flash crash"?

8.00am - Stock markets open slightly lower on ongoing concerns over the financial situation in Greece, as well as uncertainty emanating from elections in the UK, and the upcoming jobs report.

Stock markets open slightly lower on ongoing concerns over the financial situation in Greece, as well as uncertainty emanating from elections in the UK, and the upcoming jobs report. 2.00pm - The Dow drops 161 points, or 1.5 per cent.

- The Dow drops 161 points, or 1.5 per cent. 2.42pm - The Dow falls a further 3.9 per cent to 10,445.84 points.

- The Dow falls a further 3.9 per cent to 10,445.84 points. 2.47pm - The index suddenly sheds another 5.49 per cent in five minutes of trading, hitting 9,872.57, meaning it's now down 9.16 percent from the previous day’s close.

- The index suddenly sheds another 5.49 per cent in five minutes of trading, hitting 9,872.57, meaning it's now down 9.16 percent from the previous day’s close. 3.00pm - Stocks rise again, reducing its total decline to 4.26 per cent, or 463.05 points.

- Stocks rise again, reducing its total decline to 4.26 per cent, or 463.05 points. 4.30pm - The index ends the day at 10,520.32, 3.2 percent from the prior day’s close.

The United States' Securities and Exchange Commission and its Commodity Futures Trading Commission (CFTC) subsequently issued a joint report on the "flash crash" of May 6th.

The report blamed the crash on a large sell order for "e-mini" futures on the S&P 500 by a mutual fund. These are a financial product which reflect investor confidence for the future performance of the S&P 500.

It said the order placed that day was so large it overwhelmed the market, as there weren't enough available buyers, and consequently liquidity evaporated, causing prices to plummet.

How does Navinder Singh Sarao fit into this?

The CFTC has alleged Sarao's financial trading company had been entering into and subsequently withdrawing from thousands of orders in a bid to depress the price of the "e-mini" futures on the S&P 500. When the prices fell he swooped, buying them up, and profiting accordingly.

They say his behaviour contributed to the fact that, when a huge trade was executed over in the United States, there wasn't enough liquidity, and the market was unable to handle it....

The great flash crash of 2010: What happened to the Dow Jones and what is Navinder Singh Sarao supposed to have done?
How an Indian-origin trader caused the 2010 ‘flash crash’ · 2015

An Indian-origin futures trader has been arrested in the U.K. and faces extradition to the U.S. for his alleged role in the May 2010 “flash crash” which wiped billions of dollars off the value of U.S. shares in minutes.

Navinder Singh Sarao (37) was arrested by British authorities yesterday at the request of the U.S. Department of Justice and the U.S. is requesting his extradition.

Mr. Sarao was charged in a federal criminal complaint in the Northern District of Illinois in February 2015.

The complaint charges him with one count of wire fraud, 10 counts of commodities fraud and commodities manipulation and one count of “spoofing”, a practice of bidding or offering with the intent to cancel the bid or offer before execution.

The U.S. Commodity Futures Trading Commission (CFTC) also announced the unsealing of a parallel civil enforcement action against Mr. Sarao and his firm Nav Sarao Futures Limited.

The CFTC complaint charges him with unlawfully manipulating, attempting to manipulate, and spoofing with regard to the E-mini S&P 500 near month futures contract.

The E-mini S&P 500 is a stock market index futures contract based on the Standard & Poor’s 500 Index and is one of the most popular and liquid equity index futures contracts in the world. The contract is traded only at the Chicago Mercantile Exchange (CME).

According to allegations in the criminal complaint, Mr. Sarao allegedly used an automated trading programme to manipulate the market for E-Mini S&P 500 futures contracts on the CME.

From April 2010 to present, he and his firm have profited over $40 million in total from the E-mini S&P trading.

Mr. Sarao’s alleged manipulation contributed to a major drop in the U.S. stock market on May 6, 2010, that came to be known as the “Flash Crash”. On that date, the Dow Jones Industrial Average fell by approximately 600 points in a five-minute span, following a drop in the price of E-Minis.

According to the complaint, Mr. Sarao allegedly employed a “dynamic layering” scheme to affect the price of E-Minis.

By allegedly placing multiple, simultaneous, large-volume sell orders at different price points — a technique known as layering — Mr. Sarao created the appearance of substantial supply in the market.

As part of the scheme, he allegedly modified these orders frequently so that they remained close to the market price, and typically cancelled the orders without executing them. When prices fell as a result of this activity, Mr. Sarao allegedly sold futures contracts only to buy them back at a lower price.

“Today’s actions make clear that the CFTC, working with its partners on the criminal side, will find and prosecute manipulators of U.S. futures markets wherever they may be,” CFTC Director of Enforcement Aitan Goelman said.

In its ongoing litigation, the CFTC is seeking permanent injunctive relief, disgorgement, civil monetary penalties, trading suspensions or bans, and payment of costs and fees.

U.S. District Judge Andrea Wood has issued an order freezing and preserving assets under Mr. Sarao and his firm’s control. The court has scheduled a hearing for May 1, 2015, on the CFTC’s motion for a preliminary injunction....

How an Indian-origin trader caused the 2010 ‘flash crash’
British Trader Navinder Sarao Arrested Over 2010 Flash Crash · 2015

The mystery over the May 6, 2010 Flash Crash took a turn on Tuesday when the Department of Justice said it arrested Navinder Singh Sarao, a little known trader working from his home near London's Heathrow Airport, for allegedly playing a key role in that day's tumult through a series of large, market-manipulating trades.

The arrest comes nearly five years after the Flash Crash, when the Dow Jones Industrial Average inexplicably fell almost 600 points in a matter of minutes, only to quickly reverse those losses. The crash lasted roughly 20-minutes and caused stocks such as Accenture to trade at a penny before thousands of trades were cancelled. It also created significant downward pressure on shares of companies as large as Procter & Gamble - trades that were upheld by the Securities and Exchange Commission.

Although the crash proved temporary, it raised concern about the stability of U.S. stock markets and opened scrutiny into the electronic trading venues and so-called high frequency trading firms that now account for bulk of trading activity.

While some parties such as asset manager Waddell & Reed and a trading algorithm from Barclays Capital were seen as having an impact on the day's trading tumult, no arrests were made until Tuesday.

In a joint investigation with the Commodity Futures Trading Commission, the DoJ alleges Sarao contributed meaningfully to the 2010 crash. Sarao is accused of one count of wire fraud, 10 counts of commodities manipulation and one count of 'spoofing,' the DoJ said in a complaint unsealed on Tuesday. Sarao's alleged manipulation occurred over a handful of years and as recently as this month.

In its complaint, the DoJ said Sarao modified an algorithmic trading program so that he could 'layer' together a hand full of large sell orders on index futures contracts on the S&P 500 - called E-Mini's - with sell orders coming at different price levels that were continually modified so they would stay outside the market price where trades might be executed. By cycling the algorithm on and off several times during a trading day, the DoJ alleges Sarao create large imbalances in E-mini's that impacted overall market prices, allowing Sarao make profits by selling futures contracts ahead of market declines and buying them back before an eventual recovery.

On May 6, Sarao is alleged to have used the layering algorithm continuously for the two hours prior to the crash, applying close to $200 million worth of persistent downward pressure on the E-mini S&P price and representing between 20%-to-29% of the entire sell-side order book.

While the trades came ahead of the market crash, they "contributed to an extreme E-mini S&P order book imbalance that contributed to market conditions that led to the Flash Crash," the DoJ said in a press release. In total, Sarao is alleged to have made $879,018 in profits during the flash crash, a small sliver of the $40 million haul he is alleged to have made over five years from manipulative trading.

"Defendants have engaged in a massive effort to manipulate the price of the E-mini S&P by utilizing a variety of exceptionally large, aggressive, and persistent spoofing tactics," the CFTC added in a civil complaint.

However, Sarao's alleged involvement, uncovered through a whistle-blower, raises new questions about the crash and regulators' apparent inability to understand the causes and culprits of the crash. An investigation into the crash laid much of the blame on Waddell & Reed and an algorithm it licensed from Barclays. Now, the Sarao investigation indicates that illegal trading tactics such as 'spoofing' and 'layering' were a major cause of the market tumult.

The complaint also shows that exchanges such as Chicago Mercantile Exchange and regulators tolerated Sarao's allegedly manipulative and market-destabilizing trading for years. In fact, the CME even contacted Sarao on the day of the flash crash to warn that, "all orders entered on Globex during the

pre-opening are expected to be entered in good faith for the purpose of executing bona fide transactions."

Later that day, regulators allege Sarao made tens of thousands of essentially fake orders that wound up playing a key hand in one of the worst market crashes in U.S. history. About the CME's warnings, Sarao said he told the exchange "to kiss my ass," in a correspondence with his broker.

In spite of a troubling new narrative five years after the flash crash, regulators characterized Sarao's arrest as a victory. “Today’s actions make clear that the CFTC, working with its partners on the criminal side, will find and prosecute manipulators of U.S. futures markets wherever they may be,” CFTC Director of Enforcement Aitan Goelman said in a statement.

The CFTC is seeking disgorgement, fines and trading suspensions. Sarao was arrested by British authorities in the United Kingdom and is awaiting extradition....

British Trader Navinder Sarao Arrested Over 2010 Flash Crash
UK speed trader arrested over role in 2010 'flash crash' · 2015

WASHINGTON (Reuters) - A high-frequency trader was arrested in London over his alleged role in the May 2010 “flash crash” that briefly wiped out nearly $1 trillion in market value, the first time authorities have blamed manipulation for the turbulence.

The U.S. Justice Department said on Tuesday that it had criminally charged Navinder Singh Sarao, 36, of London, with wire fraud, commodities fraud and manipulation.

Sarao allegedly used an automated program to generate large sell orders that pushed down prices. He then canceled those trades and bought the contracts at the lower prices to benefit when the market recovered, authorities said.

“His conduct was at least significantly responsible for the order imbalance that in turn was one of the conditions that led to the flash crash,” said Aitan Goelman, head of enforcement at the Commodity Futures Trading Commission, which filed parallel civil charges against Sarao on Tuesday.

The case marks the first time U.S. regulators have alleged that market manipulation played a role in the flash crash, in which the Dow Jones Industrial Average plunged more than 1,000 points before recovering somewhat toward the end of trading.

Prosecutors said the Chicago Mercantile Exchange’s self-regulatory staffers caught wind of some of Sarao’s suspicious trades as early as 2009. He reaped some $40 million between 2010 and 2014 trading the futures contracts known as “E-minis,” according to the DOJ complaint.

An October 2010 report by the CFTC and Securities and Exchange Commission found that one of the contributing factors in the flash crash was a computer-driven trade by a mutual fund which chose to sell a large number of E-mini S&P 500 futures contracts. It did not mention market manipulation.

Reuters had earlier identified the trader as Waddell & Reed Financial Inc. Goelman said he would not comment on the role that other institutions played in the crash.


The arrest is likely to renew scrutiny of high-frequency and automated trading, widespread practices that have been controversial ever since the flash crash and especially after Michael Lewis’s 2014 bestseller “Flash Boys” said that equity markets were rigged.

The case was set in motion by a whistleblower who had provided the CFTC with analysis on the trades, said Shayne Stevenson, a lawyer at Hagens Berman Sobol Shapiro LLP, who represented the whistleblower.

“That CFTC and DOJ teamed up to combat market manipulation ... and to arrest him for this conduct, sends a strong deterrent signal,” Stevenson said.

Sarao, who allegedly set up one firm called Nav Sarao Milking Markets Ltd, made use of tactics deployed in the past by high-frequency traders such as “layering” and “spoofing,” under which traders place orders that they cancel before they are executed to create the false impression of demand.

The exchange contacted him in March 2009 and again the day of the flash crash to make sure he was placing orders “in good faith.” It was not clear whether it linked Sarao to the flash crash at that time. The CME declined to comment.

But according to the complaint, Sarao later that month sent off an email to his futures brokerage, saying he had called the CME and “told em to kiss my ass.”

The downward spiral on the day of the flash crash started in the E-mini S&P 500 futures contracts, which are traded on the CME, and the contagion quickly spread into the equities market, wreaking havoc.


The event has prompted U.S. regulators to adopt safeguards to prevent such drastic market drops.

The CFTC said Tuesday that Sarao’s alleged manipulation continued at least through early April of this year. Manipulation cases are notoriously hard to prove, and can often take years to come to fruition.

Traders on Tuesday were skeptical that Sarao could have triggered the flash crash on his own. One said that spoofing was a tactic employed routinely on the market, not just on the day of the flash crash.

“It just feels like a heck of a stretch to me. It looks unfortunately more to me like a Witch Hunt where people are trying to get a name associated to a problem so everybody can say the case was solved,” this trader said, speaking on the condition of anonymity.

U.S. regulators estimated that Sarao reaped $879,018 in net profits from his trading on the day of the flash crash alone.

The Justice Department said it plans to request that he be extradited to the U.S.

At the modest house on the outskirts of west London where both Sarao and his trading firm were listed in the Justice Department complaint as being registered, there was no answer when a Reuters reporter sought comment on the story.

The sun sets on the address where Nav Sarao Futures Limited is registered, in Hounslow, London April 21, 2015. REUTERS/Neil Hall

British police said he will appear at a London court on Wednesday.

Sarao used automated trading programs to execute his scheme, the two regulators said, describing in detail how he sent massive sell orders into the m...

UK speed trader arrested over role in 2010 'flash crash'
'Flash Crash' arrest shakes investors' confidence · 2015

CLOSE The cause of the 2010 Flash Crash keeps changing, and the latest who-done-it conclusion has met with skepticism on Wall Street. Jason Allen

Investors question how a small-fry trader moves markets, and why regulators let it go on so long.

Traders work on the floor of the New York Stock Exchange on a day when the Dow Jones Industrial Average dropped about 1,000 points, in New York. Computers were blamed for the so-called "Flash Crash." (Photo: Henny Ray Abrams, AP)

The arrest of a London trader who allegedly helped cause the 2010 Flash Crash isn't boosting investors' confidence. It's spooking them.

"If this one random guy could impact billions of market value in seconds or milliseconds, what's going on?" billionaire entrepreneur Mark Cuban said in an interview.

"If a guy in his underwear can manipulate markets, anybody can. The optics look really, really bad," said Cuban, who owns the Dallas Mavericks NBA basketball team.

Investors from Wall Street to Main Street are expressing bewildered concern over Navinder Singh Sarao's alleged role in the Flash Crash on May 6, 2010, which caused the Dow Jones industrial Average to plunge nearly 600 points in five minutes.

The drop erased hundreds of billions in market value before the Dow inexplicably recovered minutes later. It left investors shell-shocked and sent regulators scrambling for ways to prevent such a dramatic plummet from happening again.

Sarao was arrested in London on Tuesday and said in court Wednesday that he opposed extradition to the USA to face charges.

Joe Saluzzi, co-founder of Themis Trading, which executes trades for large investors, called the details surrounding Sarao's arrest a "confidence-shattering event."

He questions whether other traders may be engaged in market-moving activities, and why it took regulators so long to catch on.

"I would like to hear from the (regulators) why did it go on for five years? And can they tell us confidently that there's no one else doing this currently?" Saluzzi said.

The Chicago Mercantile Exchange, or CME Group, questioned Sarao numerous times about his trading in 2010, only to be brushed off, according to the Justice Department's criminal complaint against Sarao, unsealed Tuesday.

In March 2010, a few months before the crash, Sarao allegedly asked CME whether its questions about his trading meant CME was ready to go after "mass manipulation" by high-frequency traders, according to the DOJ.

In a statement, CME said it is reviewing the Commodity Futures Trading Commission's claim, also released Tuesday, that Sarao was partially responsible for the crash.

"Following the Flash Crash on May 6, 2010, together with other regulators, we did a thorough analysis of all activity in our markets during the Flash Crash, and concluded — along with regulators — that the Flash Crash was not caused by the futures market," CME Group said in a statement. "If new information has come to light, we look forward to reviewing it with the (CFTC)," the statement said.

Sarao's alleged activities went from 2009 through this year and earned him an estimated $40 million in profits, said Aitan Goelman, head of enforcement at the CFTC. Authorities charge he manipulated a popular stock market futures index for his gain by placing large contract orders and quickly canceling them before they were executed.

Adding to concerns, the CFTC was alerted to Sarao's alleged misdeeds by a whistle-blower, who has not been identified, according to Shayne Stevenson, who represents the whistle-blower through Hagens Berman law firm in Seattle. Stevenson said his client brought "high-quality information" about "market manipulation" to the CFTC, which alerted the DOJ.

Stevenson declined to specify when his client went to the CFTC with the information.

One investor says the episode reminds him of the Bernard Madoff fraud case. Madoff, a securities broker, ran a Ponzi scheme that stole billions of dollars from investors. Regulators didn't catch on for years despite warnings, and the scheme finally fell apart in 2008 with Madoff's arrest.

"This reminds me of the Madoff scandal in that it took a private investigator to figure out what happened," said Stanley Haar, a commodities trader with Haar Capital. "Trading those huge volumes, this guy should have been caught within a week," Haar said of Saraoo.

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'Flash Crash' arrest shakes investors' confidence
Why the Cause of the 2010 Stock Market Flash Crash Really Matters · 2015

At about 2:30pm on May 6, 2010, an asset management firm began executing a series of orders on the Chicago Mercantile Exchange. Located in Overland Park, Kansas, Waddell & Reed was (and is) one of the oldest mutual fund companies in America. It followed a strategy based on fundamental analysis—Wall Street code for old-fashioned investing. That afternoon, it wanted to sell 75,000 futures contracts on the S&P 500, a major market index, before the market closed at 4 p.m. The order was large but basically unremarkable, and Waddell & Reed had been executing similar trades for decades.

But this time something was different. Within 20 minutes of Waddell & Reed’s initial order, S&P 500 futures had declined 5 percent, and individual equity prices began to oscillate wildly. The price of the consulting firm Accenture declined from roughly $30 to $0.01 in seven seconds. Consumer goods giant Procter and Gamble dropped from around $60 to $39. Shares of Apple tumbled 20 percent from their pre-crash price of approximately $250, and also traded at nearly $100,000 per share (trades which were later annulled by the exchange). The dramatic futures move and the massive and sudden dislocation in the equities markets on that day came to be known as the Flash Crash.

How did the Flash Crash happen? The Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) arrived at one explanation in their official joint report, published in September of 2010. According to the report, many of the firms that bought the initial batch of futures from Waddell & Reed used automated trading software. Each purchase introduced additional market exposure and risk, prompting these trading programs to hedge their own risk by selling these same futures. Other automated traders took the other side of these trades, then also sought to offload their risk in the market. Each trade that Waddell & Reed made therefore caused multiple trades in response. In addition, Waddell & Reed had instructed their own trading program to trade no more than 9 percent of the total volume of the futures contracts traded at any given time, so that their algorithm didn’t trade too aggressively. But the algorithm wasn’t given any restrictions on price, or the time it should take to finish its order. It began to ramp up its own volumes exponentially in response to the activity that it itself had initiated, all the while maintaining its 9 percent volume cap. As the firms buying from Waddell & Reed accumulated risk, they began to require more incentive to continue buying futures. Prices began to fall. And since the different firms that were trading with Waddell & Reed’s orders also were generally using similar algorithms, their behavior became strongly correlated, pushing the markets in the same direction: down.


But then, almost as quickly as it had started, the crisis resolved itself. During the next few minutes, following an automatically triggered pause in futures trading, firms began to see the depressed market as a buying opportunity. Trading systems were reactivated and liquidity was restored. The market recovered to almost to its pre-crash level.

Some commentators remain skeptical of the SEC-CFTC’s official explanation. For example, the Chicago Mercantile Exchange, where the trades were executed, argued that a trade of the sort that Waddell & Reed had executed was too small, or too common, to explain such an extreme and unusual event. Firms like Waddell & Reed may make dozens, even hundreds, of similar trades without a hitch every year. Then just this past Tuesday, on April 21, a United Kingdom-based futures trader called Navinder Singh Sarao was arrested on wire fraud and market manipulation charges. He stands accused of placing large sell orders in S&P 500 futures without ever intending to have those orders fulfilled. Instead, regulators and prosecutors allege, his orders were intended to trick the market by increasing sell pressure on the futures. Regulators allege that the trick worked, making Sarao millions of dollars in profit. Furthermore, regulators have taken pains to emphasize that he employed this strategy on the day of the Flash Crash. His activity caused a sudden loss of liquidity and “directly contributed to the ... price crash,” according to the CFTC’s complaint.

Also in Economics Drowning in Light By Dirk Hanson In 1996, Yale economist William D. Nordhaus calculated that the average citizen of Babylon would have had to work a total of 41 hours to buy enough lamp oil to equal a 75-watt light bulb burning for one hour. At...READ MORE

Like a nuclear power plant, modern markets are both interactively complex and tightly coupled.

So which explanation captures the dynamics that led to the crash? Could an ordinary order in the futures market or a lone market manipulator really cause the crash? The simple answer is that this is the wrong question to ask. From the perspective of the joint report and the...

Why the Cause of the 2010 Stock Market Flash Crash Really Matters
The 'flash crash' trader: Here's how much he allegedly made. · 2015

Nearly five years after the so-called “flash crash”—when the market dropped hundreds of points in the span of a few minutes on May 6, 2010—authorities have arrested a trader that they believe helped cause the swoon.

But the alleged culprit, a U.K.-based futures trader named Navinder Singh Sarao, didn’t actually make a whole lot of money off the flash crash, according to the U.S. Justice Department’s criminal complaint against Sarao.

The complaint, which accuses Sarao of manipulating market prices by fraudulently trading S&P 500 futures contracts, says that he netted $879,018 in profits on the day of the crash.

But that was a relatively small haul compared to Sarao’s gains on other days where he used the same strategy, according to the indictment. For example, more than a year later, on August 4, 2011, Sarao allegedly reaped more than $4 million by manipulating the prices of the same kinds of contracts.

Sarao’s strategy, described in the 35-page complaint by FBI special agent Gregory Laberta, involved placing large orders for electronic S&P 500 futures contracts known as “E-minis,” only to cancel them before the orders were actually executed. The practice is known as “spoofing” and it is illegal.

Using automated trading software, Sarao allegedly placed repeat bogus orders to sell huge blocks of E-minis, artificially pushing the market price of the futures contracts down. Once the price dropped, he would then execute real trades to buy the contracts at the lower price, while simultaneously cancelling his original sell orders. Next, he would turn around and use spoofing to drive the price of the contracts back up, actually selling some at the higher price while cancelling the rest of his fake orders.

Between 2010 and 2014, Sarao made a total of roughly $40 million using that strategy—and he was still actively spoofing through at least the first week of April, according to a separate civil complaint against Sarao by the U.S. Commodity Futures Trading Commission.

But if Sarao’s actions really did lead to the flash crash, it’s unclear why they only caused a single one—especially when that wasn’t even his biggest windfall amid a long-running scheme.

Indeed, Sarao’s conduct on the day of the flash crash actually seems pretty ordinary for him, by the FBI agent’s account. Over a period of two hours starting in the early afternoon New York time, when the Dow was down by more than 300 points, Sarao allegedly traded more than 62,000 E-mini contracts worth $3.5 billion. But for him that was nothing: The previous day he’d traded E-minis worth more than double that amount (or $7.6 billion); the day after the flash crash, he traded some $8.7 billion of them. (According to an email Sarao sent in 2012, cited in the complaint, the trader bragged that he “made the majority of [his] net worth” in “no more than 20 days trading.”)

Still, the day of the flash crash, Sarao’s spoof orders somehow created an “extreme order book imbalance” on the Chicago Mercantile Exchange (CME), the primary place where E-minis are traded. During the two-hour period just before the flash crash, as much as 29% (or nearly a third) of the sell orders on the exchange were coming from Sarao, according to the criminal complaint. At that time, there was “little liquidity left in the market,” as there were more than twice as many sell orders as buy orders for E-mini futures contracts, the complaint says.

And that’s when the market went into free fall—triggering the “flash crash” at about 2:45 p.m. As investors (or their algorithmic trading programs) noticed what appeared to be a major fire sale of E-minis, the sell-off “spilled into equities markets” as traders dumped stock: The Dow shed another 600 points in a matter of five minutes, and was briefly down by 1000 points.

And if E-minis trading had caused the crash, all it took was a quick timeout to stop the chaos: the CME halted trading in E-minis for five seconds, and the market mostly recovered by 3 p.m.

The very next day, it was rinse-and-repeat for Sarao, who kept up his spoofing routine as though nothing ever happened, according to the complaint. So why hasn’t there been another flash crash since (other than the brief 2013 swoon following a hoax tweet about a White House attack)?

One theory is that it wasn’t just Sarao, but a confluence of spoof traders or price manipulators who caused the market imbalance; Sarao is simply the only one—or perhaps just the first—to get caught. It just may take another flash crash for government regulators to find the others.

Watch more business news from Fortune:...

The 'flash crash' trader: Here's how much he allegedly made.
Wall Street 'Flash crash' explained: How 'the Hound of Hounslow' could have caused one of the scariest days in stock market history · 2015

What was the Flash Crash?

One of the most scary and bizarre days in Wall Street’s history. On 6 May 2010, the Dow Jones Industrial Average Index plummeted by 6 per cent in a matter of minutes - an unprecedented single-day fall. The shares of some enormous American companies such as General Electric and Accenture were virtually worthless at one point and $1 trillion in the paper value of shares was suddenly gone. And then the Dow promptly shot back up again, recovering almost all of the earlier losses leaving traders and regulators traumatised and baffled.

How could one trader be responsible for such mayhem?

We’ll tell you what’s true. You can form your own view. From 15p €0.18 $0.18 USD 0.27 a day, more exclusives, analysis and extras.

He wasn’t really. Navinder Singh Sarao stands accused by the US financial regulators of illegally manipulating the Chicago Mercantile Exchange futures market in equities to turn a private profit. The wording of the US Department of Justice charge sheet is that Sarao’s activities on 6 May “contributed” to the Flash Crash by creating an “extreme order book imbalance” in the futures market.

A court sketch shows Navinder Singh Sarao opposing his extradition to the US at Westminster magistrates’ court

What exactly is Mr Sarao accused of doing?

The main manipulation technique outlined by the US authorities is so-called “layering” or “spoofing”. This means a trader places a large number of fraudulent electronic orders to sell futures contracts. These orders are visible to other traders and indicate lots of market desire to sell. That prompts them to drive the price of a contract down. The accusation is that Mr Sarao then cancelled the orders prompting prices to bounce back up. He allegedly managed to profit from the price swing by buying contracts when they were artificially low and selling them back when the price snapped back. It’s illegal because the markets rules say that orders have to be made in good faith and with the intention to complete.

How did this destabilise the main stock market?

Prices in the futures markets influence prices in the main market. The US authorities seem to be claiming that Mr Sarao’s futures manipulation helped to create a kind of financial avalanche on the day of the Flash Crash which spilled over from the futures market and engulfed the main market.

So was he one of those “high-frequency traders” we hear about?

Not really. Those traders – written about by Michael Lewis in his recent book “Flash Boys” are characterised by their use of a vast amount of computing power and privileged access to electronic stock market infrastructure. This combination gives them the ability to react to (and thus profit) from price movements more quickly than others, leading to accusations that the market is effective skewed in their favour. The accounts of Mr Sarao’s one-man company show that the value of his computer technology in 2010 was just £1,400. Mr Sarao also described himself to the UK financial regulators as an “old-school point and click” trader who had “always been good with reflexes and doing things quick”. Ironically, his profits may well have come at the expense of sophisticated high-frequency traders because they will likely have been the ones selling quickly when fraudulent orders come through.

Did he make much money from his activities?

According to the US regulators he did. They estimate he made around $879,000 on the day of the Flash Crash. They also think he creamed off $40m from his manipulation of markets over the next four years (although it is unclear where these proceeds have gone). And incidentally, the fact Mr Sarao’s manipulation was allegedly going on for so long is one of the reasons many in the financial markets are sceptical of the idea that his activities played any significant role in the 2010 crash. If his futures market manipulation was the driver of the chaos on 6 May one would have expected many more massive market crashes in subsequent years.

Is this the only sort of market manipulation that takes place?

Far from it. Traders, in private, outline a host of others techniques of questionably legality. One is “quote stuffing”, which effectively creates uncertainty in markets for other traders by making a large numbers of orders and issuing a stream of updates. Another is “momentum ignition” which is a series of orders intended to start or accelerate a trend favourable to a particular trader. There are also “ping orders”, tiny buy or sell requests which are intended to ascertain the level of concealed orders in a market....

Wall Street 'Flash crash' explained: How 'the Hound of Hounslow' could have caused one of the scariest days in stock market history
UK-Indian Navinder Singh Sarao arrested over role in 2010 'Flash Crash' · 2015

From a modest stucco house in suburban west London, where jetliners roar overhead on their approach to Heathrow Airport, a small-time trader was about to play a hand in one of the most harrowing moments in Wall Street history.Navinder Singh Sarao was as anonymous as they come—little more than a day trader by the standards of the Street.But on that spring day five years ago, US authorities now say, Sarao helped send the Dow Jones Industrial Average on the wild, 1,000-point ride that the world came to know as the flash crash. By regulators’ account, he was responsible for a stunning one out of five sell orders during the frenzy. On Tuesday, he was arrested by Scotland Yard and charged in the US with 22 criminal counts, including fraud and market manipulation. The news left many grasping for answers. Sarao, 36, has no record of having worked at a major financial firm in the US or the UK. At the time of the flash crash, Sarao was renting space from a proprietary trading firm in the City of London and clearing his transactions through MF Global Holdings, the now-defunct firm headed by Jon Corzine, said a person with knowledge of the matter. One of Sarao’s neighbors in Hounslow, 11 miles from central London, said what neighbours so often say: He was quiet, kept to himself, never caused trouble.That picture, according to US authorities, belies a years-long history of lightning-quick computer trading that netted Sarao $40 million in illicit profits. Sarao couldn’t be reached for comment on Tuesday and US authorities said they didn’t know whether he had retained a lawyer. Sarao didn’t cause the flash crash single-handedly, authorities say. Nonetheless, Tuesday’s developments fly in the face of the prevailing narratives of what happened. Regulators initially concluded that a mutual fund company— said to be Waddell & Reed Financial of Overland Park, Kansas — played a leading role. Many in the industry countered that a confluence of several forces, including high-frequency trading, was probably behind the crash.By all accounts, the flash crash was more than a mere technical glitch. It raised fundamental questions about how vulnerable today’s complex financial markets are to the high-speed, computer-driven trading that has come to dominate the marketplace.Little is known about Sarao and his trades, beyond what is contained in a complaint filed by the US Department of Justice. A related civil suit filed by the US Commodity Futures Trading Commission provides a few additional glimpses into his supposed activities. The case stemmed from a whistle-blower who brought “powerful, original analysis” to the CFTC’s attention, said Shayne Stevenson, a Seattle lawyer representing the whistle-blower.According to US authorities, Sarao spent the past six years thumbing his nose at regulators while using software designed to manipulate markets. In addition to fraud and manipulation, he was charged with spoofing — an illegal practice that involves placing orders with the intent to cancel before they’re executed. In May 2010, Sarao’s actions created imbalances in the derivatives market that then spilled over to stock markets, exacerbating the flash crash, according to the CFTC.“We do believe and intend to show that his conduct was at least significantly responsible for the order imbalance that in turn was one of the conditions that led to the flash crash,” Aitan Goelman, the CFTC’s director of enforcement, told reporters on Tuesday.When he was trading, Sarao kept to himself. His computer screen almost always flashed futures data tied to the Standard & Poor’s 500 Index and his interactions were typically limited to workers installing new trading algorithms, said the person, who spoke on the condition of anonymity.When he started his allegedly manipulative trading in 2009, Sarao used off-theshelf software that he later asked to be modified so he could rapidly place and cancel orders automatically. At one point, he asked the software developer for the code, explaining that he wanted to play around with creating new versions, according to regulators....

UK-Indian Navinder Singh Sarao arrested over role in 2010 'Flash Crash'
2010 Flash Crash Arrest Motivated By Greed · 2015

Whistleblower Program

The past week we have made markets safer by arresting the dangerous flash crash villain who was a threat to national security and the health of the entire financial market system. Like I always say when in doubt follow the money trail in identifying motives and what is really going on here in this Flash Crash arrest.

In this case there is this whistleblower who is trying to cash in on the U.S. Commodity Futures Trading Commission's (CFTC) whistleblower program, created after the 2010 Dodd-Frank Wall Street regulatory reform bill which awards tipsters between 10 percent and 30 percent of the total sanctions collected if the government collects $1 million or more.

Small Fry

The trader Navinder Singh Sarao who traded from the suburbs of London has made an estimated 40 Million dollars in profits from trading over the time period in question with his questionable trading practices and the CFTC will go after the full amount. The whistleblower could net between $4 million to $12 million for his 'original analysis' of the 2010 flash crash depending on what the legal proceedings are able to claw back from the trader.

DOJ Involvement

It is easy to see how the DOJ got involved since they have been regularly involved in making high profile cases against Wall Street over the last several years. It is good for their visibility effort, and making a name for those involved in the department and enforcement function.

Publicly Available Information

The problem is that there is nothing 'original' in this analysis on behalf of the whistleblower, this type of high frequency trading market manipulation goes on every day in every financial market in almost every asset class across the broad trading spectrum. It has been outlined by everybody from Nanex, Zero Hedge, Michael Lewis and many others in the industry. Computer driven market manipulation strategies are so pervasive in financial markets, they are far worse today than the flash crash period of 2010, and incorporated not just by the HFT firms, but by the large financial institutions, hedge funds, market makers, and many other market participants.

Does the DOJ really want to go down this Rat Hole?

Literally the problem for the DOJ is that if this guy is guilty, then the DOJ has to arrest the entire financial community, because all the DOJ or CFTC has to do is pull up a Trading Dom (Depth of Market) price ladder in anything from bonds, oil to S&P 500 futures and spoofing and many other volume based manipulative trading practices are regularly occurring right out in the open on a large scale. The real indictment here is that the CFTC or the DOJ needs any type of original analysis to identify this type of illegal trading activity, as it happens right out in the open for everybody to see. You don`t even have to pull trading records to see it, it is just that blatant. It has definitely gotten progressively worse from the 2010 period. In fact, spoofing is so commonplace that market participants probably don`t even think a millisecond whether it is an illegal tactic to manipulate prices. Furthermore, the arrest for spoofing sure didn`t scare any firms from incorporating this spoofing strategy because it was happening every day last week, and as of Friday`s trading was as rampant as ever in Friday`s price action.

Follow the Money Trail

Why go after this small trader? This frankly just shows the ignorance by the DOJ and the CFTC on this matter, they could go after Goldman Sachs, JP Morgan Chase and every other major financial institution for spoofing, as the practice has been adopted across the trading community as acceptable behavior. When the oil market has 8 or 9 Spoofing events going on at the same time, and the sizes and capital necessary to enact such strategies, it is pretty obvious that more than just a few high frequency trading firms are employing spoofing to influence market direction for profits.

Why go after 40 million from this small independent trader, this is peanuts for the DOJ, they could easily go after another 100 billion in fines from the likes of Deutsche Bank, UBS, Morgan Stanley, HSBC, Bank of America and the entire lot of the large financial institutions. I guarantee you traders at all the large financial institutions employ volume based and spoofing manipulative price action influencing strategies on a daily basis. It has just become that pervasive due to the advent of sophisticated computer programs and algo based trading programs. Why do you think Goldman Sachs went so ballistic over that proprietary trading program that the developer who left Goldman Sachs wanted to take with him at his next position? Most of the data represented on the price displays regarding bids and offers and volume is completely artificial and fake, created by computers for the sake of deception, and gaining an advantage; everyone knows this in the trading community. Nobody in the options community believes anything they see as to the posted bids and offers or...

2010 Flash Crash Arrest Motivated By Greed
'Flash Crash' a Perfect Storm for Markets · 2015

The flash crash has proven one of the most mysterious market events in recent history. Many observers still believe the event hasn't been fully investigated. Their view is fueled in part by new allegations that a London trader's manipulative trading helped set up the market for a crash that day.

Scroll down to see how the day unfolded....

'Flash Crash' a Perfect Storm for Markets
"The flash crash" five years later · 2015

- pencer Platt/Getty Images

Listen To The Story Marketplace Embed Code

May 6, 2015, marks the five-year anniversary of the so-called ‘flash crash’ on the New York Stock Exchange. That day, the Dow Jones Industrial Average plummeted more than 1,000 points, before regaining much of its ground by the end of the day.

The causes of the flash crash are still debated, but certainly included a combination of civil unrest and market volatility sparked by the European debt crisis, plus high-frequency trading. Another key factor is now thought to be market manipulation by a single rogue trader in London, who was allegedly "spoofing" S&P futures (in particular, the S&P 500 E-mini contract). That trader, Navinder Sarao, 36, was charged last month in the U.K.

Similar cases have followed.

On May 5, 2015, in Manhattan federal court, the Commodities Futures Trading Commission, working with the Chicago Mercantile Exchange, filed civil charges against two traders in the United Arab Emirates. They allegedly spoofed the gold and silver markets from February to April 2015.

University of Maryland law professor Michael Greenberger, a former director at the CFTC, says "embarrassment" over the 2010 flash crash revelations seem to be galvanizing securities regulators to identify and track down alleged market manipulators. But he says the Obama Administration’s prosecutorial approach isn’t helping, as it has favored civil over criminal charges in most securities-fraud cases since the financial crisis.

“The cleanest and clearest way to stop people from doing these things is the real possibility of ending up in jail,” says Greenberger. When traders and their firms face only civil charges, Greenberger continues, “they pay penalties. Penalties are a cost of doing business. Spending time in prison is the most effective deterrent to the fraudsters.”

Greenberger also believes part of the blame for lax enforcement against spoofing and other attempts to manipulate market prices lies with the equity and futures exchanges themselves. He charges that the Chicago Mercantile Exchange, for instance, has dueling incentives—to ensure market integrity, but also to generate profits from higher trading volume, which high-frequency trading provides. Greenberger also says members of Congress, acting to help financial firms that are also big campaign contributors, have not adequately funded federal securities regulators like the CFTC and SEC.

Karen Petrou, a banking analyst at Federal Financial Analytics in Washington, D.C., believes that since the flash crash in 2010, the problem of market manipulation by participants with sophisticated technology for super-fast online trading has only gotten worse—in U.S. markets and overseas. She cites recent examples in the past year, including flash crashes on the German and Swiss markets and in the U.S. bond market. Petrou attributes much of the problem to under-regulated high-frequency traders.

“In its algorithm, in a nanosecond, a liquidity or temporary market phenomenon will give the high-frequency trader a teeny-tiny advantage,” says Petrou. “And if you do that a lot, very, very fast, you can make a lot of money.”

All of that rapid-fire computer-driven and -executed trading increases volatility and systemic financial risk, she says—not just for investors, but also for big banks.

“We are seeing flash crashes in the equity, treasury, foreign exchange and bond markets,” says Petrou. “We should be very scared. I know regulators are. But they’re not acting.”

A multi-agency plan conceived after the 2010 flash crash to monitor and prevent attempts to manipulate the markets has so far been mired in technological complexity, corporate rivalry and regulatory delays.

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"The flash crash" five years later
What actually caused 2010 "Flash Crash" · 2016

Reuters The search for causation over the May, 2010 "flash crash," a one hour near 1,000 point loss and recovery on the Dow Jones Industrial Average, is a complex topic but one important to accurately document.

Such quantitative market mishaps only have the potential to cause more economic damage as society becomes increasingly dependent on technology and "artificial" intelligence.

Initially regulators publicly blamed a "fat finger" on the market sell-off that had no fundamental basis as a computer, not a finger, was involved. But a more nuanced and detailed report pointed to a single market participant for causation.

In support of the initial regulatory finding is a January 25 report challenging U.S. prosecutor conclusions, but does this report de-emphasize a key component?

Is analysis of what drives pricing — and a market participants providing two-sided liquidity that was simultaneously withdrawn during crisis— missing from meaningful analysis? This is not to diminish the report — it provided interesting insight on several levels.

It is to point out that any flash crash analysis might do well to consider how traders at the time were aware of certain market manipulation techniques relative to the underlying algorithmic market structure.


Navinder Sarao was not solely responsible for the flash crash

A new report from two University of California and one Stanford University academics claim to know who should not be blamed. In a draft report titled "The Flash Crash: A New Deconstruction," they say it is "unlikely that… Navinder Sarao's spoofing orders, even if illegal, could have caused the flash crash."

Sarao faces criminal charges in Chicago for intentionally manipulating markets using the "spoofing" tactic during the flash crash and on other occasions.

Spoofing is a trading technique that is designed to deceive the electronic market making system into moving markets in a beneficial direction to the trader. The technique has been a concern as it could damage market structure security, particularly the case in 2010 as the market making systems at the center of the flash crash were in the early stages of development.

This "spoofing" statement is perhaps most interesting not for claiming Sarao didn't cause the flash crash - causation is likely a more complex and not singular in its conclusion and claims he was singularly responsible have been widely disputed.

But the report, in acknowledging the existence of Sarao's "spoofing" orders, points to a commonly known tactic that has been the subject of criminal attention from authorities.

In part, spoofing works by intentionally creating order imbalances in both quotes — messages sent into the exchange that have been interpreted as indications of market balance — as well as actual sell orders designed to be executed immediately.


Key market security issue at center of spoofing charges

Such spoofing has been successfully prosecuted. In the past, authorities would treat harshly anyone who engaged in behavior deemed damaging to overall market structure security, including manipulating market systems or abusing segregated funds laws.

While the report comes to Sarao's defense in regards to his role as a "but for" cause of the flash crash — meaning if he was not involved, the crash would not have taken place — it might not tip the scales in court as it does not absolve Sarao of the more encompassing charges of market manipulation, an acknowledgement Sarao himself made in emails sent to his computer programmer designing the system.

Regarding flash crash causation, the report tends to side with the initial joint SEC-CFTC staff report on the topic that said "prevailing market conditions combined with the introduction of a large equity sell order implemented in a particularly dislocating manner" was the guilty party, pointing a finger at Kansas-city based mutual fund Waddell and Reed, the alleged "fat finger."

The report noted a "disruptive" trading pattern but did not provide analysis of the Waddell and Reed market order that was said to have rested on the higher "ask" side of the bid-ask spread and was done over multiple smaller orders.

This was hotly debated among practitioners at the time, and a then CFTC source claimed it caused significant tension between the two regulators. The losing force in the battle wanted to raise questions regarding known methods of manipulating the market making system and disputed the notion of pointing blame at any one organization.

The report then hits a key market security topic: "If Sarao's relatively small-scale trading could in fact generate the large-scale effects asserted by the government, modern equity market structures could be viewed as alarmingly fragile."

Those fighting a battle inside regulators, generally defending market security issues, wanted full academic discussion of the issue to be public.


Market making software had "eye" feature that detected anomolistic behavior and order imbalances, but th...

What actually caused 2010 "Flash Crash"
Navinder Sarao: The man accused of causing the US market to crash · 2016

Image copyright Getty Images Image caption Navinder Sarao, the so-called "flash crash" day trader has been fighting attempts to extradite him to the US

Navinder Sarao, who traded from his parents' home in Hounslow, west London, has been accused of market manipulation that caused a 1,000-point fall on the US Dow Jones index in 2010.

He faces 22 charges in the US, including fraud charges, all of which he denies - which include "spoofing" - the practice of buying or selling with the intent to cancel the transaction before execution.

Set aside for a moment Navinder Sarao's guilt or innocence. What he did was astonishing.

From a computer in the bedroom he'd grown up in, at his parents' semi-detached house under the Heathrow flight path, this casually dressed 37-year old traded remotely on an exchange in Chicago he had never visited.

In less than five years he made more than £30m.

Computerised trading

Pause for thought. He was operating on the Chicago Mercantile Exchange, a highly computerised market where normal human beings stand little chance.

Computers operating so-called high frequency trading programmes pick up any sign of prices moving up or down - and jump in ahead of normal, slow-motion human traders.

Image copyright Getty Images Image caption Computers will always beat humans when it comes to trading

You, the human trader, may see an order to buy pop up on your screen half a second after it's published on the exchange. It may be big enough to move the market up - so you could make money if you could buy quickly.

But because you're up against computers, by the time you click 'buy' it's already too late. Your brain took half a second to process the visual information - whereas a computer picked it up in a few milliseconds.

The high frequency traders bought, the price rose - and you lost your chance to make money.

In Chicago, the pressure is fierce to see buy and sell orders just a few milliseconds ahead of the other guy.

Millisecond advantage

As outlined in Michael Lewis's brilliant expose Flash Boys, a few milliseconds' head-start is worth so much money that the most determined traders buy expensive property close to the exchange and spend large sums installing super-fast cables - so the signal arrives just a few milliseconds faster.

Why? Because if your computerised trader gets the information two or three milliseconds before others, you can make money.

Image copyright Getty Images Image caption But computerised trading does have a weakness, especially if the computers are programmed to react in similar ways

If it's a big buy order your computerised trader can buy ahead of others, "riding the trend" and adding to upward pressure on prices.

The others who get the information a flash later can't "get in at the ground floor". Instead they buy after prices have already risen. And they're buying at those inflated prices from you - as you sell out for a quick buck.

'Spoofing' the computers

What Navinder Sarao seems to have worked out, like others before him, was that the high frequency trading made the market twitchy.

Because many of the high frequency traders were programmed with similar software - designed, for example, to spot a large volume of buy orders and then ride the trend - they would all do more or less the same thing.

Like a pack of sheep sent one way or another by a sheepdog, they could be spooked.

Or rather, "spoofed". According to the FBI's investigators, Nav Sarao had modified a commercially available piece of software - a trading algorithm, to do just that.

Image copyright Getty Images Image caption The FBI didn't only accuse Mr Sarao of placing fake orders to manipulate the market, it also accused him of helping to cause the flash crash

Using that software and at high speed, they alleged, he was placing big sell orders, sometimes amounting to hundreds of millions of dollars a day - trades with which he never intended to go through.

Instead they were designed to make the rest of the market (the computerised traders) believe the sell orders outweighed the buy orders, indicating the market was about to head down.

Sheep-like, the computerised traders would sell in order to avoid losing too much money as prices dropped. The weight of selling would push prices down.

Meanwhile (according to the FBI) Mr Sarao would have placed a real buy order waiting for the market to drop. He would then buy at the lower price and cancel the sell orders.

When the market realised the sell orders had gone away, prices would bounce back. And Mr Sarao could then sell at that higher price and bank a profit.

That profit might be tiny. But if this operation were repeated hundreds of times per hour, the profits could be handsome.

Crucially, according to the FBI, those orders were fake, designed to "spoof" the market. Sarao didn't intend to go through with them. And that spoofing is an offence under US law.

The FBI didn't only accuse Sarao of placing fake buy and sell orders to manipulate the market. It also accused him of ...

Navinder Sarao: The man accused of causing the US market to crash
Top 3 Financial Crashes Caused by High-frequency Trading Algorithms · 2017

In the financial world, high-frequency trading has become the new norm. By using trading algorithms and dedicated tools, stock market players can execute trades in milliseconds. The ultimate goal is to increase profits in a near-automated way. However, there have been some notable issued with high-frequency trading in the past, all of which have caused significant financial losses in the process.


Although flash crashes are nothing new in the world of finance and trading, 2010 stands out as a peculiar year. On May 6 of 2010, the US stock market crashed and remained inaccessible for a total of 36 minutes. All stock indexes collapsed and rebounded in quick succession. This day marks the second-largest Intraday point swing recorded up until that moment.

The cause of this crash took some time to pinpoint. As it turns, high-frequency trading algorithms were driving the bids on dozens of ETFs and other stocks as low as one penny per share. Navinder Singh Sarao was eventually convicted for his role in the 2010 flash crash, as he used a spoofing algorithm to cause the crash. He set up thousands of futures contracts, which were refreshed roughly 19,000 times before eventually getting canceled. It is this type of high-frequency trading algorithm that caused the brief crash....

Top 3 Financial Crashes Caused by High-frequency Trading Algorithms
2010 Flash Crash · 2018

What is the 2010 Flash Crash?

The 2010 Flash Crash is the market crash occurred on May 6, 2010. During the 2010 crash, leading US stock indices, including the Dow Jones Industrial AverageDow Jones Industrial Average (DJIA)The Dow Jones Industrial Average (DJIA), also commonly referred to as "the Dow Jones” or simply "the Dow", is one of the most popular and widely-recognized stock market indices, S&P 500, and Nasdaq Composite Index, tumbled and partially rebounded in less than an hour. The day was distinguished by high volatility in trading of all types of securities, including stocksStockWhat is a stock? An individual who owns stock in a company is called a shareholder and is eligible to claim part of the company’s residual assets and earnings (should the company ever be dissolved). The terms "stock", "shares", and "equity" are used interchangeably., futures, options, and ETFsExchange Traded Fund (ETF)An Exchange Traded Fund (ETF) is a popular investment vehicle where portfolios can be more flexible and diversified across a broad range of all the available asset classes. Learn about various types of ETFs by reading this guide..

Although the market indices managed to partially rebound in the same day, the flash crash erased almost $1 trillion in market value.

2010 Flash Crash: Main Events

Beginning in the morning, trading on major US markets on May 6, 2010 showed a negative trend. It was mainly due to concerns regarding the financial situation in Greece and the upcoming elections in the UK. By afternoon, the major indices of equities and futuresFutures ContractA futures contract is an agreement to buy or sell an underlying asset at a later date for a predetermined price. It’s also known as a derivative because future contracts derive their value from an underlying asset. were down by 4% from their previous day’s close.

By 2:30 p.m., trading was becoming extremely turbulent. The Dow Jones Industrial Average (DJIA) lost almost 1,000 points in around 10 minutes. However, in the next 30 minutes, the index recovered almost 600 points.

Other market indices across North America were also affected by the Flash Crash. The S&P 500 Volatility Index increased by 22.5% on the same day, while the S&P/TSX Composite Index in Canada lost more than 5% of its value in between 2:30 p.m. to 3:00 p.m.

By the end of the trading day, the major indices regained more than half of the lost values. Nevertheless, the Flash Crash took away around $1 trillion in the market value.

Investigation of the 2010 Flash Crash

After the Flash Crash, the US Securities and Exchange Commission (SEC) conducted an investigation of the possible causes of the unexpected market event. In September 2010, the SEC published a report containing the findings of its investigation.

According to the report, before the flash crash, the markets were particularly fragile and were exposed to extreme turbulence. A single selling order of an enormously large amount of E-Mini S&P contracts and subsequent aggressive selling orders executed by high-frequency algorithms triggered the massive decline in market prices, which was already accruing exponentially due to prevailing negative market trends at that time.

The immense volatility compelled many high-frequency traders to halt their trading. The trading of E-Mini S&P contracts was paused to prevent it from further declines. When the trading of the contracts resumed, their prices started to stabilize. The markets started to regain their positions as the prices of many securities returned to near their initial levels.

The DJIA on May 6, 2010 (11:00 AM – 4:00 PM EST)

After the Flash Crash

The results of different investigations of the 2010 Flash Crash led to conclusions that the high-frequency traders played a significant role in the crash. The aggressive selling and buying of large volumes of securities resulted in enormous price volatility in the financial markets. At minimum, the activities of high-frequency traders exacerbated the effects of the crash.

In 2015, London-based trader Navinder Singh Sarao was arrested following allegations of market manipulation that resulted in the Flash Crash. According to the charges, Sarao’s trading algorithm executed a number of large selling orders of E-Mini S&P contracts to push the prices down, which ultimately triggered the market crash.

Related Readings

Thank you for reading CFI’s explanation of the Flash Crash. CFI offers the Financial Modeling & Valuation Analyst (FMVA)™FMVA™ CertificationThe Financial Modeling & Valueation Analyst (FMVA)™ accreditation is a global standard for financial analysts that covers finance, accounting, financial modeling, valuation, budgeting, forecasting, presentations, and strategy. certification program for those looking to take their careers to the next level. To learn more about related topics, check out the following resources:...

2010 Flash Crash
The 2010 Flash Crash · 2018

On May 6, 2010, at approximately 2:32 pm EST, all three U.S. stock indices–The Dow Jones Industrial Index, S&P 500, and the Nasdaq Composite–underwent a massive plunge and a partial rebound over a 36-minute period.

In just a matter of minutes, the Dow Jones logged its second largest intraday drop, crashing 998.5 points (9%) before rapidly bouncing back. Short of any fundamental trigger, the crash seemed to have been caused by nothing of economic substance; an anomaly appearing out of nowhere; a trillion-dollar “Black Swan” event, to which there seemed to have been no trace of an explanation.

If you were tuned into CNBC’s live broadcast, you might have seen this verbal exchange which at that exact moment was focused on P&G’s (Procter & Gamble) 37% stock plummet (transcript via Wikipedia):

(“Let’s take a look at P&G. Alright, this is going to say everything. P&G is now down 25%.”)

Jim Cramer: Oh, well, that’s true, if that stock is there you just go and buy it. That—it can’t be there. [pointing finger] That is not a real price. Oh well, just go buy Procter. Just go buy Procter & Gamble, they reported a decent quarter, just go buy it.

(“Is there a hedge fund that is liquidating?”)

Jim Cramer: Eh… Who cares?! I’ll pay… a 49 + 1/4 bid for 50,000 Procter, if I were at my hedge fund. I mean, this is ridi… this is a good opportunity. When I walked down here it was at 61—when I walked down here it was at 61, I’m not that interested in it. It’s at 47, well that’s a different security entirely, so what you have to do, though, you have to use limit orders, because Procter just jumped seven points because I said I liked it at 49.

So, what happened on that day?

A lot of theories were presented as industry professionals, regulators, and academics strove to make sense of it all.

One popular theory was the “fat-finger error,” that a trader inadvertently sold a large position of stocks such as that of Procter & Gamble. This type of error can be likened to someone who accidentally types in too many digits when placing a trade, turning an order of, say, a hundred thousand into a few millions or even more.

Another theory was that multiple automated trading systems converged, placing sell orders at the same time, causing the markets to fall, in turn prompting even more asset liquidations. This is a negative feedback loop in which sell orders prompt a continuous cycle of even more selling which ultimately results in a massive avalanche of liquidations.

These were just two of several other theories put forward over the next few years. All of them equally valid; none of them certain.

Finding the Culprit Five Years Later

It wasn’t until 2015 that the mystery behind the first-ever flash crash was finally solved. It had been discovered that a London-based trader by the name of Navinder Singh Sarao was using an algorithmic program to generate massive sell orders on the E-mini S&P futures to manipulate prices downward by getting other people to sell (as they would see his large orders). As Sarao never intended on selling any contracts, he would wait for prices to move down, cancel his sell orders, buy E-mini S&P futures at the lower market prices and then sell them back once prices moved up again upon sellers realizing that the order flow was no longer skewed toward the downside. In short, Sarao was “spoofing.”

Sarao was arrested in April 2015 with charges issued by the U.S. Department of Justice. The Commodity Futures Trading Commission filed a separate civil suit against him. Later that year, he was eventually extradited to the U.S. facing 22 charges of fraud and market manipulation.

Sarao’s alleged profit during the flash crash: $40 million. And to think, he managed to pull this off all from the comforts of his own home.

It was also discovered that he had been inconspicuously spoofing the markets for five years. The thing is, if you cause the market to temporarily lose $1 trillion in value, it’s hard to go unnoticed and thus, ends Sarao’s brilliant, brief, and painfully unrewarding spoofing career.

There is a substantial risk of loss in trading futures, options and forex. Past performance is not necessarily indicative of future results....

The 2010 Flash Crash
Herding and flash events: Evidence from the 2010 Flash Crash · 2018

Using intraday data on individual stocks included in the S&P 500 index, we present evidence of herd formation over the duration and aftermath of the Flash Crash on May 6, 2010, while no evidence of herding is observed preceding the event. The findings establish a clear link between herding among market participants and flash events that can drive sudden price fluctuations and underscore the importance of monitoring herd activity, particularly in the case of automated markets....

Herding and flash events: Evidence from the 2010 Flash Crash
Herding and Flash Events: Evidence From the 2010 Flash Crash · 2018

Using intraday data on individual stocks included in the S&P 500 index, we present evidence of herd formation over the duration and aftermath of the Flash Crash on May 6, 2010, while no evidence of herding is observed preceding the event. The findings establish a clear link between herding among market participants and flash events that can drive sudden price fluctuations and underscore the importance of monitoring herd activity, particularly in the case of automated markets....

Herding and Flash Events: Evidence From the 2010 Flash Crash
if reforms aren't ramped up, the next one could spell global disaster · 2019

In California, people fear the “big one” – an earthquake of such magnitude that it could wipe the state off the map. They look nervously at the intense seismic tremors from previous earthquakes and fear it is only a matter of time. The financial markets have an equivalent to these tremors: flash crashes are temporary market spikes that are a feature of modern automated trading. So far, they have passed quickly and normal business has resumed. Yet that may not be the pattern in future. The worry is that one day soon, a flash crash could bring the global economy to its knees.

Rewind to January 2, when Apple issued a profit warning, largely thanks to softer demand for Apple devices in China. The Australian dollar, used by traders as a proxy for the Chinese economy, suddenly tumbled 3.5%. Something similar happened with the Japanese yen in the opposite direction. By the end of the Asian trading session, these shifts had rebounded. Yet market watchers were in no doubt: another “flash crash” had just struck.

Flashes big and small

The first flash crash that made headlines infamously took place around 2.30pm to 3.00pm Eastern Standard Time on May 6, 2010. The Dow Jones Industrial Average suddenly tanked 10%, causing spectacular upheaval in the US futures and spot markets. A subsequent official report blamed automated trading, often known as algorithmic trading, for starving the market of willing buyers.

What saved the day was the triggering of a circuit breaker on the Chicago Mercantile Exchange, the world’s largest futures market. This stopped the market for just five seconds, but it was enough time for automated traders to discern that prices were artificially low. They duly sent manual purchases which cumulatively helped the markets to recover by driving up prices again.

Flash crashes have since become a more regular occurrence. There have been thousands of mini flash crashes, moving a market by a relatively small amount, but also more major incidents. The highlights are listed in the following table, including the crash of January 2, 2019. This doesn’t include the flash crash of December 5, 2018, which saw a sudden plunge in S&P 500 E-mini futures, the most traded futures contract in the world. In just three minutes after the day’s opening, these futures plunged 2.5%, only to rebound thanks to another circuit breaker.

So what is going on? Since around the turn of the century, financial firms have increasingly relied on algorithmic trading. It enables them to take advantage of the superhuman abilities of computers to process huge volumes of data at high speeds. Different operators use different strategies and time horizons, ranging from long-term investments by pension funds and insurance companies to short-term buying and selling by banks and brokers.

Problem predators

Most algorithmic trading is perfectly legitimate – indeed, it makes markets more efficient by increasing trading activity. It becomes problematic where it becomes predatory – manipulating other traders by giving a false impression of market demand.

Most predatory strategies involve posting then cancelling orders to buy or sell a security at a better price. Let’s say that a trading algorithm wants to sell 400 Microsoft shares at US$10 per share. The market order book, which records buyer demand, shows outstanding bids for only 50 shares at that price. This could be because, say, most trading is currently taking place at US$9.98.

To try and remedy this, our trading algorithm places a dummy bid for 450 Microsoft shares at US$10 each. Other would-be buyers are lured to place orders at the same price. This increases the number of share orders from, say, 500 to 900.

All this is happening in microseconds, so that none of this share demand has yet found a seller. Our algorithm knows exactly when its 450 order will be satisfied, and cancels just before. Instead, it instantaneously sells 400 shares at US$10 each to the buyers it attracted to the market. This is called spoofing. It was considered legitimate in the days of manual trading, but automated trading speeds have made it too effective. The same goes for other predatory strategies such as algorithm sniffing, quote stuffing, latency arbitrage and marking the close. Yet with more than half of US shares trading automated, for example, the worry is that there is still much predatory behaviour going on.

The reason these can cause or exacerbate flash crashes is that they can encourage herd behaviour – a rash of panic selling, say. This can prompt a particularly sharp price swing at a time when traders are staying out of the market because prices are too volatile – potentially spreading to other markets due to global interconnectedness, as traders begin to think that other prices must be wrong as well.

So far, flash crashes have coincided with a relatively calm bull market. But many now believe the tide has turned. The FTSE100, for example, registered its biggest fall in a decade in 2018. In a more depressed ma...

if reforms aren't ramped up, the next one could spell global disaster