Saturday, February 8, 2020

Book Review: 'Flash Crash: A Trading Savant, a Global Manhunt, and the Most Mysterious Market Crash in History' by Liam Vaughan

Too crazy not to be true

Financial investigative journalist Liam Vaughan seems to have had the time of his life putting together Flash Crash. But then, the story is so rich with characters and so bizarre in its nature, that as he admits at the end - someone had to write a book on it. It is a case of truth stranger than fiction. That cost investors billions, one memorable spring day.

The Flash Crash was an afternoon in 2010 when the financial markets suddenly melted into almost nothing, then bounced back to almost where they started that morning. For a short time (minutes!), shares of major corporations traded for a penny or less, while others shot to $100,000 a share. Blame was needed, and investigations led to a Kansas City financial house which put in  a huge sell order, rather inexpertly. But things are never that simple. In this case, it transpired that a single man, working from the edge of his bed in his parents' house in Hounslow outside London, was manipulating the markets, abusing the system until it broke.

Navinder Sarao was in his early thirties and unemployed. He still lived with his parents, and spent his weekdays playing the S&P futures for all they were worth, and more. He would routinely place trades worth billions of dollars, canceling most of them, and walking away with six figures of pure profit for half a day's work.

Bizarrely, he wasn't in it for the wealth. He lived at home, had an ordinary computer, drove a moped, and let no one know what he was doing. His parents, one ill and one working a counter in a store, never knew what he did all day. They had no clue he had run up profits approaching a hundred million dollars from his childhood bedroom. Perhaps even more bizarrely, he proceeded to lose it all on Ponzi schemes and shady con men, and when he was caught, he couldn't make bail or pay lawyers.

Sarao had adapted trading software to stack his orders at the back of their price point, and any time the market traded close by, the software would cancel his orders. So he never had to actually buy. In this way he could make it appear there was either huge demand which would send the market up, or huge selling pressure which would send it down. Either way, he was ready to profit with actual purchase orders he would hold for seconds before cashing out.

None of this is exaggerated. Here's what Vaughn says about Sarao's trading: "By any measure, NAVSAR was an outlier. In the twelve days the CFTC ended up selecting to illustrate the entity’s activity, its layering algorithm canceled or modified orders 182,000 times, corresponding to $35 trillion in notional trades—double the size of America’s gross domestic product. On eight of those days, not a single one of those orders was hit. The size of the orders was also immense: an average of 504 contracts, where the average across the market was seven."  Contracts were $75,000 each.

Four years after the event, after every American agency had its crack at assigning blame, a trader looked a the record and proved everyone - including himself - wrong. “I got pretty obsessed,” he  (still known as Mr. X today) says. “Based on the data I guessed it had to be the work of a large prop trading firm, maybe with an internal clearing arm to shield it from the authorities. The scale and the audacity of the behavior were so massive I couldn’t imagine it was one individual. As it turned out I was very wrong.”  He became a whistleblower, reopening the case just before the statute of limitations kicked in, and that led to Sarao and an international effort to bring him to justice.

Sarao never thought he did anything wrong. He thought of himself as a victim of High Frequency Trading algorithms. This was just him fighting to level the playing field. He proudly videoed his screen while trading (providing hours of fascinating insights for investigators who seized his computer). All these attitudes, approaches, tactics and sheer thoughtlessness, along with crudeness, rudeness and total lack of respect for anyone he dealt with, led to a diagnosis of Aspberger's, once he was in custody. It made some sense out of the crazy story. His math skills were awesome, his instincts spot on, and his reaction time lightning quick. He was a fearless trader, but a failing human being.

The book is fast-paced, extremely engaging, and an easy read, despite the complexity of futures trading. Vaughan has done an excellent job of making it accessible and even exciting. It's a hard one to put down. And it's not over!

In January 2020, after this book was completed and after the American authorities were finally finished with Sarao as a co-operating source, the court finally sentenced him - to two years at home. Not only is this ridiculous for all the damage he did, but it is really all Sarao wanted anyway - to be left alone at home in his familiar bedroom where he was in control and productively engaged. Worse, the US court has no enforcement power in the UK, so the sentence is meaningless. It is the perfect capstone to a story beyond belief.

Editor's note: This review has been published with the permission of David Wineberg. Like what you read? Subscribe to the SFRB's free daily email notice so you can be up-to-date on our latest articles. Scroll up this page to the sign-up field on your right.