
Guy trading at home caused the flash crash of 2010 - breitling
http://www.bloombergview.com/articles/2015-04-21/guy-trading-at-home-caused-the-flash-crash
======
bko
My (limited) understanding is that almost all high frequency hedge funds
employ this tactic of placing and cancelling limit orders. Not sure why this
guy is being prosecuted.

> We investigate the trading of one hundred Nasdaq-listed stocks on INET, a
> limit order book. In contrast to the usual view, we find that over one-third
> of nonmarketable limit orders are cancelled within two seconds [0]

When so many participants and breaking the law and the law seems to be applied
somewhat subjectively, then it is ripe for corruption and political
targetting. Kind of like how political dissidents get arrested for 'tax
evasion' in Russia

To be fair, this study was performed in 2007 and spoofing became explicitly
illegal under Dodd Frank passed in 2010.

I mentioned this in a comment in an earlier reply, but I think some skepticism
around market participants is healthy. If market participants assume that
there is no fraud or that fraud will be prosecuted by central authorities,
they will be more easily defrauded.

Edit: Looks like the number of unfilled orders is over 90%

> New data from the US Securities and Exchange Commission (SEC) show that only
> 3.2% of the orders placed in the stock market in the second quarter of 2013
> actually went through. [1]

[0]
[http://papers.ssrn.com/sol3/papers.cfm?abstract_id=994369](http://papers.ssrn.com/sol3/papers.cfm?abstract_id=994369)
[1] [http://qz.com/133695/96-8-of-trades-placed-in-the-us-
stock-m...](http://qz.com/133695/96-8-of-trades-placed-in-the-us-stock-market-
are-cancelled/)

~~~
cma
You are right that most place and cancel orders rapidly, but that isn't
necessarily spoofing, which requires some intentionality. For example, Nasdaq
even has an order type that auto-adjusts itself such that it will never
execute, but it was mainly created to help market-makers dodge quoting
requirements, not to enable spoofing.

In symbols where they are a registered market-maker, market-makers are
supposed to be obligated to make a market in the symbol. In exchange they get
several regulatory benefits, like being able to naked short a stock (sell it
without even locating/borrowing the shares).

In practice most automated market-makers used to just put out bogus quotes
they never expected to fill at $0.1/$1000000.0 bid/ask. The SEC tried to
regulate this and say you had to really be making a market and put your quotes
within X% of the current bid/ask. Market-makers started automatically
cancelling and replacing at exactly X% away, but that was too much for them.
So they had Nasdaq create an order type that automatically cancels itself and
replaces it X% away from the bid/ask anytime the NBBO changes.

What they are doing in that example is completely wrong, but not analogous to
what the guy in this article was allegedly doing (this guy put his quotes near
the money to make fake interest, market-makers put theirs as far away from the
money as possible to be fake market-makers and get regulatory benefits like
naked shorting in exchange, their orders don't appear like real buy/sell
interest in the same way this guy's allegedly did).

\---

The author of the article tries to distance algorithmic-HFT from this guy
operated, to cleanse its name, but come one:

    
    
        Sarao may have been a spoofer, but he doesn't seem to
        have been doing the sort of high-speed algorithmic
        trading that usually qualifies as "HFT." He himself 
        claimed to be "'an old school point and click prop 
        trader' who had 'always been good with reflexes and
        doing things quick,'" and the "Layering Algorithm"
        that he used was a customized version of "a program
        that allowed non-programmers to engage in automated
        trading using spreadsheet commands and functions." He
        was also the sole owner and employee of his trading
        firm, which he "operated from his residence." In style
        and substance he is not all that different from other
        spoofers we have known and loved, who did their high
        speed trading by just punching keys really fast.
    

In style and point-and-click background maybe he wasn't a goliath HFT
operation, but in substance, spreadsheet automated trading at faster than
human speeds, he definitely was.

\--

If the charges hold up, they will have been able to convict this guy because
of evidence of intentionality (the emails to his FCM). But with trading
strategies now starting to delve into modern deep-learning techniques, we're
probably going to start seeing algorithms learn to spoof from a blank slate.
The only way to tell if one of these algorithms is really intending to buy or
sell or is spoofing would be to reverse engineer something rather
inscrutable... And is it the author's intentionality or the algorithm's we're
really concerned with? Likely we'll end up holding things to some gamable
metrics that will do about as good a job as the market-maker quoting
requirements do in assuring market-maker algorithms are providing liquidity.

~~~
devinhelton
It seems like the real fix would be to have a cancellation fee. If an order is
canceled within 60 seconds, penalize the trader .1% of the total amount of the
order. That would make all this gamesmanship unprofitable, and the order book
would actually be a collection of people wanting to buy and sell shares.

It seems very wrong to me to make an activity feasible, and allow it to be
profitable, but then arbitrarily drop the hammer of criminal penalties when a
trader crosses some murky line.

~~~
pas
There already is. If you add liquidity you get a bit of a bonus, if you remove
it (cancel your limit order), you are charged a small amount.

Why are people so fixated on the order book? The real information is the spot
price and how fresh is that information (and the volume), the order book is a
fantasy anyhow. There are people willing to buy stuff at pennies always, and
sell at thousands. How does that help you? What if they cancel? It shouldn't
matter if someone does it closer to the spot price, or closer to the best bid-
offer.

If you want to buy, look at the price, decide how much you think it's worth,
put in a limit order at that price. Go to bed. If you want to sell, basically
do the same. If you want to live on trading, then smarten up.

------
mitchell_h
Could someone point out where what this guy did was illegal? The guy simply
outsmarted the algo traders by acting like he was going to push his chips in,
than yanked them back. How exactly is that illegal? And if it is illegal why
is the FCM allowing it? Even more so, how is it legal for people to see what
he MIGHT do?

This feels like a whole lot of sour grapes by the big boys. They're pissed
because someone figured out their weakness.

~~~
jonpaine
There's a technical answer, but more simply, you answered your own question:
you can't push your chips in and then yank them back.

Try that at a poker table - yes, you'll "outsmart" the other players by being
able to see their reaction. You'll also instantly break the integrity of the
game, because you're not outsmarting them, you're breaking the rules that
allow the game/market to actually function.

For a market to function properly that integrity that an order on the books is
in good faith is vital. Of course, it's up to the SEC to enforce that.

~~~
ryandvm
I think he was making the point that if something is permitted by the "rules
of the game", then by definition, it cannot be a violation of the rules. And
in the case of financial transactions APIs, the rules should exist as
application logic. So if you're not supposed to place and immediately cancel
an order, it should simply not be possible.

I could certainly believe that if it was one of the large HFTs doing this,
they would have had the necessary wheel-grease to not get in trouble...

~~~
kasey_junk
Placing and immediately canceling an order is fine and allowed (though doing
that too much is penalized for other reasons).

Spoofing is pulling them out in a coordinated fashion before they can be put
at risk with no intention of them ever trading.

The problem is that an api that prevented that would also prevent legitimate
cancels that would have side effects that could be bad (ie making it riskier
to make markets and therefore increase the bid/ask spread).

Spoofing is about intention. Intention cannot be determined by algorithm
(yet).

Also to your point about a big HFT not being subject to this. Allston trading
is a large HFT market maker that is currently in arbitration over spoofing.

------
ianlevesque
Well I sure am glad we found a scapegoat that doesn't require us to rethink
HFT in any way. /s

------
anonu
As the article points out - this guy stopped his "spoofing" strategy and the
market crash accelerated. This bit of info - coupled with the fact that it
took this long to find him makes me think that this guy is only a small part
of what happened that day.

~~~
Namrog84
Perhaps covering up more major players or corporations or even potential
underlying fundamental flaws?

------
tjradcliffe
The E-mini S&P futures market is _incredibly_ illiquid, which is why one guy
can game it this way. Look at the current volume on the June 15th contract:
[http://finance.yahoo.com/echarts?s=ESM15.CME+Interactive#sym...](http://finance.yahoo.com/echarts?s=ESM15.CME+Interactive#symbol=ESM15.CME;range=5d)

It's _343_! That's zero to a good approximation.

So this guy found a low-volume market that he could game with large sell
orders above the current price that he would cancel (automatically,
eventually) so he had a low (but crucially: non-zero) risk of actually having
to sell at that price. Others would see the large sell volume and sell
themselves, driving the price down. He would buy at the lower price, stop
placing sell orders and watch the price bounce back up, absent his
manipulation.

This is likely illegal in the letter of the law as written in 2010, and fair
enough. Illiquid markets are easily subject to this kind of thing and if you
want people to invest in them maybe you need to police them against it.
Whatever.

But to call this "the cause" of the flash crash is like saying my neighbour's
love of fireworks is "the cause" of my house burning down _after I
deliberately poured gasoline all over it_. Sure, maybe my neighbour should
have been more careful, but they had a reasonable expectation that my house
would be ordinarily fire-proof, and behaved accordingly.

And of course this guy dominated the market when it was falling rapidly: his
algorithm would have a field day in such an event, placing and cancelling
multiple sell orders as fast as it could all the way down. So to cite that as
some kind of evidence is to put effect before cause.

The only way this could have "caused" the flash crash is if a whole lot of
_large_ trading algorithms were using E-mini S&P futures as a a major input,
and doing that--using such an illiquid, easily-manipulated market to drive
large orders--that is criminal. Or should be.

~~~
minimax
Dude the front month S&P e-mini is one of the most liquid products on the
planet. You are looking at a crappy chart. Look here:
[http://www.cmegroup.com/trading/equity-index/us-
index/e-mini...](http://www.cmegroup.com/trading/equity-index/us-index/e-mini-
sandp500_quotes_volume_voi.html)

------
etaty
This is a joke, they found the poor guy who was not big enough to have friends
at the cftc. There is nothing wrong with flash crash and rally, that is just
volatility, you just use the right leverage.

~~~
jbooth
The great depression was 'just' volatility if you look at a long enough
timeline.

Flash crashes are scary for lots of reasons.

~~~
rwmj
But they're also opportunities to own parts of a company much more cheaply
than normal.

------
carsongross
There are two possibilities here: this guy has been set up as the patsy to
take the fall for this or, more terrifying, our markets are so brittle and
levered that a guy at home with no juice can wipe out a trillion in notional
value from his home.

I pray that the former is the more likely scenario as the latter is simply too
awful to contemplate.

~~~
brownegg
The latter is somewhat true, and probably unavoidable at this point. "The cat
is out of the bag", so to speak--markets can't just go back. The problem is
that the incentives are so wildly disproportionate. If a really smart guy
works for the SEC or some surveillance body, he might $200k a year. That same
really smart guy might make $200 MILLION trading. It has to be awfully damned
unlikely to not choose the latter. And in reality, you're probably pulling
$100k somehow or another while you wait.

With respect to the idea that this guy is the culprit, that's literally laugh-
out-loud funny. It's possible he was spoofing, etc., even with decent size.
But the clearing firm (Hi, MF!) controls the throttles on those pipes. But
there is what is called "sponsored direct access" in these markets, and that
basically means the clearer wants your business enough you can just hook up
directly so you can go really fast, and they (the clearer) will just pretend
that they're looking at your stuff.

~~~
filipet
200$ millions trading by themselves, without external investors? Very, very
unlikely.

------
bandrami
Old gripe of mine. I hate this phrase:

 _investors saw nearly $1 trillion of value erased from U.S. stocks in just
minutes._

No. They did not. A stock's value is not "what some other dude is payed for it
yesterday"; its value is whatever money _you_ get when _you_ sell it (plus,
God forbid, whatever dividends it pays -- quaint idea, I know).

------
pdovy
It's worth pointing out that this kind of behavior gets people in trouble on a
fairly regular basis, what is new is that the DOJ is starting to bring
criminal complaints.

It's long been the case that the SEC, or in this case the CFTC, will fine and
temporarily/permanently ban you from trading for this kind of behavior, look
at
[http://www.cftc.gov/LawRegulation/Enforcement/EnforcementAct...](http://www.cftc.gov/LawRegulation/Enforcement/EnforcementActions/)

------
jacknews
Oh No! We should BAN guys trading from home! Only licensed professionals,
employed by the big banks, should ever be given such responsibility!

------
IanDrake
It seems most likely that another algorithm was looking at the full book and
reacted to his spoofing order with it's own orders (that were actually
executed) and which accelerated the price downward. This would have tripped
algos looking at momentum and other stop loss orders in rapid succession.

This is why it's dangerous to have algos run on the full book, especially
without some logic to remove outliers.

------
matt_morgan
Thank goodness for Matt Levine. I read three other articles on this earlier
today that didn't even raise the questions that he answered.

~~~
mtanski
He is like the John Stuart of Fin reporting.

------
danbruc
I have an solution for you - instead of in real time trade in rounds every
minute or ten or even only once an hour. Now everyone has some time to think
about his decisions. And the real world doesn't change much within a couple of
minutes so no need to worry that you can not react to events in a timely
manner.

~~~
princeb
problem with this soln can be seen in exchanges' auction sessions: sessions of
several minutes/hours during which orders only net at the end. with visible
orderbook this does not avoid the problem of spoofing or eliminate the value
of speed. with invisible orderbook there is still benefit in placing trades
right at the last moment before the netting because you continue to accrue
micromkt information from continuously trading markets and economic info from
the real world throughout the netting session. and if you want to make all
exchanges in all locations of the world net at the same exact moment, this is
a Hard Problem.

~~~
danbruc
But with an invisible order book you face the trade-off between submitting
your orders early an get priority over later orders and submitting late to
incorporate the latest information.

~~~
princeb
in netting phases the queue is almost entirely price based and not time based.

------
defen
I can't help but think, "if it's really that easy to crash the market, how
come terrorists aren't doing it on a regular basis?" Seems way easier, safer,
and more effective than shooting people or blowing them up.

~~~
pyre
You can't die in a blaze of glory (possibly) on the world stage from behind a
computer screen.

------
dankohn1
One guy in his pajamas caused a market crash? How many of these events will it
take to cause a fundamental rethink of the financialization of our economy?
Where are the supposed benefits to justify finance gobbling up more than a
third of corporate profits [0]? When will we finally see a financial trading
tax [1] that ends High frequency trading (HFT) for good?

[0] [http://angrybearblog.com/2012/01/where-has-all-money-gone-
pa...](http://angrybearblog.com/2012/01/where-has-all-money-gone-part-ii.html)
[1]
[http://en.wikipedia.org/wiki/Financial_transaction_tax#Unite...](http://en.wikipedia.org/wiki/Financial_transaction_tax#United_States_financial_transaction_tax)

------
justonepost
I'm sure it was a collection of Sarao's that did this, rather than Sarao
alone. He probably just stood out and was easiest to prosecute. Hopefully more
prosecutions are coming.

------
T-zex
HN Mods, why this discussion was dropped two pages down?

~~~
kasey_junk
Not a mod but I believe that there is an "HFT penalty". And probably rightly
so. The discussions around HFT are notorious for not being very productive.

------
jlebrech
so the system was the culprit

