The 2010 Flash Crash might have been all over the news with the news of the latest arrest of Navinder Singh Sarao on Tuesday, but still some people are unclear what exactly happened and how big a deal it was. On May 6, 2010 the U.S. stock markets and the Dow Jones index had trended down for most of the day. There was anxiety about Greece’s debt crisis and falling euro prices. The market was extremely tensed that day and general elections were being held in U.K. which led to the country’s first coalition government, in British history, to form because of election outcomes.
By 2:42pm, the Dow Jones index was already down by 300 points when the equity market began to fall rapidly. The index plunged down by another 600 points, in the next five minutes. The sequence of events which led to the index losing almost nine percent of its value came to be called the 2010 Flash Crash or the Crash of 2:45 pm.
By 3:07pm, most of the 600 points had been recovered and the market closed just three percent lower. In those 25 minutes, about $1 trillion was temporarily wiped out and approximately two billion shares had been traded with the total volume exceeding $56 billion. It took the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) almost five months to investigate what led to the 2010 Flash Crash and to release a report. The report cited a large trade in E-mini futures contract earlier in the day that set off the crash.
On Tuesday, it was revealed by the CFTC that Sarao, a British trader had a hand in the crash and his activities contributed to the market conditions that led to the flash crash.” The new complaints alleged the Sarao, 36, turned on an algorithm that uses high-speed trading techniques to spoof the market at around 12:17 pm. Spoofing influences the market prices by creating fake demand or supply. Sarao then proceeded to trade 62,0777 E-mini S & P contracts via his company, Sarao Futures Ltd. The notional value of those contracts is $3.5 billion. Sarao had been doing this previously too, and the complaints allege that he made a profit of $40 million over a period of several years. He was charged with 22 counts of fraud and market manipulation.
Sarao set off a chain reaction which led to 2010 Flash Crash. The Wall Street Journal reported that Waddell & Reed Financial Inc., a Kansas based trading firm, then sold a total of 75,000 E-mini contracts in the next 15 minutes. This was followed by high-frequency trading firms trading roughly 140,000 E-mini contracts.
Sarao’s arrest on Tuesday was questioned by many as they complained that he was being made a scapegoat. He is fighting extradition to the U.S. and has been able to offer a $7.5 million conditional bail. The fact that the arrest came almost five years after the actual incident also caused people to question what the SEC and the CFTC had been waiting for and if Sarao had been involved in such high volume trading why he had not been caught before. John Hempton, manager of Bronte Capital Management and an Australian fund manager wrote in support of Sarao. He called Sarao a hero who made the market safe for ordinary investors and stood up in his defense. The Chicago Mercantile Exchange also concluded that the 2010 flash crash was not a result of futures market trading.
Investor’s meanwhile, are disturbed that a guy running a company from his parent’s basements could do so much harm. “If a guy in his underwear can manipulate markets, anybody can. The optics look really, really bad,” Mark Cuban told USA Today. The billionaire and owner of the Dallas Mavericks NBA team also questioned how Sarao was able to do that and escaped notice before this.
Sarao’s contribution to the Flash Crash and his subsequent arrest on Tuesday led to a joint SEC and CFTC report on ways to prevent such a situation from happening again. The 14-page report goes on to detail ways to ensure the “integrity of the markets and to maximize investor confidence” in the wake of recent market disruptions. They suggest that data dissemination was a factor which led to the volatility of the market being exacerbated. Electronic traders did not know the point at which the trades were broken and as a result many withdrew. There was also a call for a consolidated audit trail for the U.S. equity market, which would help the regulators keep pace with the changing technology as they were unable to do so prior to the 2010 Flash Crash.
By Anugya Chitransh
Photo by Rafael Matsunaga – Flickr License