Flash Crash by Liam Vaughan [Book Summary – Review]

At times, reality can be unbelievable compared to fiction. If a person were to tell a story about a young British man who by himself caused the collapse of the worldwide financial market from his childhood room, you might think it is an exaggerated story.

However, this is precisely what transpired. Navinder Singh Sarao made a program capable of outsmarting the markets, but it also wreaked havoc on them in the process – if only for a short period on the 6th of May 2010. This incident was called the Flash Crash and this left skilled economists puzzled.

What led to this event? What were the repercussions? And was Sarao truly accountable for it? This book tells the story of this occurrence and the main figure– the person now referred to as the Hound of Hounslow.

In this book, you will discover

  • the meaning of trading futures;
  • How algorithms surpassed human traders; and
  • means of damaging the international financial market.

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Chapter 1 – Experts are puzzled by the quickest decline ever witnessed in the global financial market.

The economy worldwide was not in a good state in the year 2010. In the aftermath of the 2008 crash, the Eurozone was still facing problems, with nations like Greece and Italy particularly facing challenges. There was widespread fear of spread, where even small negative news had the effect of triggering widespread economic fear.

This was what happened to the dramatic incidences of May 6 – an economic decline that occurred reality fast that the majority of people, including skilled market traders, failed to grasp.

Therefore, what transpired?

The S&P 500 index, which monitors 500 of the largest US companies, reduced by 5 percent in just four minutes, this happened at 1:41 p.m. Central Standard Time. The Dow Jones index followed suit, experiencing a greater drop in five minutes than it had throughout its whole 114-year history. Concurrently, individual stock prices plunged, resulting in making stock charts resembling sheer cliff edges. Across the globe, from Shanghai to Frankfurt, financial markets spiraled into panic mode.

Subsequently,  a global spin-off marketplace known as the Chicago Mercantile Exchange, activated its automatic stop-logic feature, halting every trading for five seconds. When trading started, the markets astonishingly began to recover.

However, during that 15-minute interval, some highly unusual occurrences took place. Certain stocks plummeted to astonishingly low levels – for instance, the iShares Russell 1000 Value Index dropped from $50 to one ten-thousandth of a cent. Conversely, shares of tech guru Apple and auction house Sotheby’s increased to $100,000 per share. For a fleeting moment, the world seemed to be in chaos.

Yet, these are more than mere abstract numbers. What did this event, often referred to as the “Flash Crash,” actually entail for individuals with investments at stake? Well, countless normal people around the globe have lost out.

Consider Mike McCarthy, a father of three from South Carolina who was currently unemployed. He had gotten a little stock portfolio that was willed to him following his mother’s passing the previous year. Observing the market downturn, he became anxious and hastily instructed his broker to start selling off his holdings. Unluckily for him, his order coincided with the market collapse, resulting in a loss of $17,000 – equivalent to eight months’ worth of mortgage payments.

As for the cause of this abrupt crash, at that point, no one knew.

Chapter 2 – The core of the mystery revolves around Navinder Sarao, a talented but bit-known trader.

After gathering more information, US authorities traced the investigator’s path to Hounslow, a serene suburban area on the outskirts of London. 

In a modest semi-detached house, lived 35-year-old Navinder Singh Sarao together with his parents. He was the person believed by US authorities to be responsible.

However, who was he? 

Navinder, often referred to as Nav, was born into a working-class family to parents who emigrated from Punjab, India to the UK during the late 1970s.

As an intelligent kid, he displayed exceptional skill in mathematics at a young age. Mastering his multiplication tables at the tender age of three through the electronic game known as  “Little Professor.” He was seen multiplying lengthy numbers off his head at school. He didn’t require pen and paper to show his workings just like his peers would.

 Afterward, Nav pursued studies in computer science and mathematics at Brunel University, situated only a few miles away from Hounslow. Like many of his friends, he didn’t have money. However, one of the people living with him always had money. Nav was fascinated and questioned him where he got the money from. The response was trading. This was the start of Nav’s fervent interest in the stock market. 

After his university education, Nav secured a position at Independent Derivatives Traders in 2003. Impressing the company’s founders, brothers Paolo and Marco Rossi, with his lightning-fast arithmetic skills during the interview, despite his somewhat awkward and unpolished behavior.

Surrey the firm, situated right above a supermarket in Weybridge recruited aspiring traders and provided them with comprehensive training during an in-depth training period.

After a brief period, Nav found his rhythm at IDT, similar to other trading firms was complete machismo. Seeking solitude from this situation, he secluded himself at a desk positioned at the furthest corner of the trading floor, using heavy-duty ear defenders to focus better.

Leveraging his mathematical prowess, Nav delved into trading futures markets. His intense concentration was evident to all and they were aware not to distract him. He monitored his two screens closely, engaging in trading activities involving the e-mini futures contract of the S&P 500 index, resulting in substantial earnings.

Immediately, Nav emerged as one of the firm’s most valuable assets.

Chapter 3 – Exceptional futures market speculators challenged by emerging technology.

Different from his colleagues at IDT, Nav stood out as an unconventional figure who didn’t fit as a typical trader. While a lot of his fellow traders flaunted their newfound wealth, Nav appeared content with a diet centered around McDonald’s Fillet-O-Fish sandwiches and consistently wore inexpensive sweaters to the office daily.

However, he amassed significant gains for both himself and the firm, which had undergone a name change to Futex at that point. What specific tasks did Nav undertake in his role?

In simple terms, futures are financial agreements wherein one party commits to selling a certain thing to another at an agreed-upon price on a future date. Initially, the primary aim of futures contracts was to enable businesses to hedge against various forms of risk.

This is an illustration: A poultry farmer is aware that she has to feed her chickens six months from now, so she decides to purchase a quantity of corn today for a fixed amount. This ensures that any potential increase in the price of corn between now and the future date won’t impact her expenses, as she has already agreed to a set price. While there is a risk of losing out if the price of corn decreases, the farmer gains the benefit of stability, knowing exactly what amount she will pay.

Another category of investor has emerged within the futures market: the speculator. Should a speculator anticipate a decline in the price of corn, possibly due to favorable harvest forecasts, they may choose to sell corn futures contracts with the hope of repurchasing them at a lower price in the future. This type of investor isn’t interested in the corn itself; instead, they view it simply as another asset to speculate on, similar to Microsoft stocks or gold.

From the start, futures were exchanged on the bustling trading floor. Paolo Rossi, one of the founders of Futex started his career in the future pit as it was called, set at London’s Royal Exchange.

However, with the advent of modern technology, trading futures has become accessible to anybody who has an internet connection. Operating from the Futex office, Nav took advantage of this technological advancement by speculating on the performance of the American stock market with remarkable precision.

However, around 2007, trading got more difficult Nav. There was the rise of high-frequency trading: an approach that utilizes costly cutting-edge technology and algorithms that respond to market circumstances at a pace surpassing human capability.

Indeed, even quicker than Nav himself.

Chapter 4 – Deprived of opportunities in the futures market, Nav develops a strategy to exploit loopholes in the system.

Nav, a skilled trader, could assess new information within a fraction of a second, but the advent of high-frequency trading technology allowed for responses in mere millionths of a second.

This rendered it impossible for Nav to accurately interpret market signals. Just as he decided on a bid, prices would suddenly shift against him. This gave him the impression that somewhere, unseen, strong traders with their brand-new technology could anticipate all his moves.

Essentially, Nav felt as though the system was unfairly biased against him.

Previously, Nav had held faith in the market, believing that talent could yield profits regardless of one’s background. That was liberating for someone like him, a working-class boy.

However, these cutting-edge computer programs transformed that. Instantly, the market favored those with access to such technology, for instance, the big hedge funds.

Nav continuously felt as though he was personally aimed at and outplayed by these forces. Determined to gain an advantage, he came up with a plan. He thought that while computers excelled at interpreting present data if he could manipulate the data itself, he could outsmart the machines.

Teaming up with a computer programmer, he created a program to achieve exactly that. In the trading world, this tactic is called spoofing: essentially, deceiving other traders by placing and then canceling orders. By placing a substantial order, one could impact the price of a specific asset.

As a trading strategy, it’s an old tactic. Daniel Defoe, the English writer, describes spoofing practice in eighteenth-century London. Sir Josiah Child, a governor of the East India Company, instructed his brokers to act despondently and spread negative rumors about a particular stock. This induced other traders to sell, causing the price to plummet. The child would then capitalize on the situation by purchasing the stock at a reduced price.

Nav’s program, the Autotrader, basically replicated this approach but at an accelerated pace. It would place huge orders on a futures contract, manipulate the price movement, and instantly retract them before the market reacted. Nav would then capitalize on the situation by swopping in with actual purchase orders.

Not too long, Nav had effectively outplayed the algorithms and began making huge profits—more than even a skilled soccer player.

Chapter 5 -Authorities sluggish to find the creator of the program believed to be responsible for the market crash.

On the 6th of May, 2010, Nav activated his Autotrader program as he normally did. 

Having parted ways with Futex earlier, he now traded all by himself. Nav likes trading from his childhood bedroom, located at his parents’ residence in Hounslow. Beautifying his bedroom wall was a pair of pink soccer boots hung there, autographed by, Lionel Messi, one of the world’s best players. Nav was generating close to £900,000 daily, surpassing Messi’s earnings at FC Barcelona by sevenfold.

As Nav’s Autotrader program put in huge orders and subsequently withdrew them, the markets were experiencing a terrible day. Just a minute later he shut down the program at 1:41 p.m. CST, and the markets started a huge crash. Was he responsible for it?

Following the crash, various rumors arose regarding its cause, ranging from notions of a terrorist attack to errors attributed to a solo trader. However, American authorities swiftly honed in on what they deemed as the likely cause: a significant mutual fund known as Waddell & Reed, which had sold an unusual volume of futures contracts that fateful day.

Official reports written by two commissions suggested that the crash resulted from a perfect storm, just like the complicated circumstance that led to the First World War.

However, an unidentified trader residing in Chicago referred to as just Mr. X, delved deeper into the matter. Utilizing his software, he meticulously investigated the crash data. His analysis led him to suspect a single entity’s involvement, he assumed that the cause was a major financial institution instead of a single trader.

Mr. X brought his findings to the Commodity Futures Trading Commission. Following an extensive investigation, the commission identified an entity named NAVSAR. Subsequently, they traced this entity to a semi-detached residence in Hounslow, where Nav resided with his parents.

On the 21st of April, 2015, marking five years since the crash, British law enforcement officers arrived at Nav’s parents’ residence. Nav’s father greeted them, composed himself, and summoned Nav from his room. Appearing downstairs, Nav, was in his customary tracksuit pants and sweater, and he looked drowsy.

That was when they apprehended their suspect.

The official charges levied against Nav? Fraud and market manipulation.

Chapter 6 – The case of Navinder Sarao raises inquiries about the finance industry.

Nav was granted bail after spending four months in Wandsworth Prison in London. Subsequently, on the 7th of November, 2016, he was deported to the United States to face the charges against him. Eventually, in January 2020, he got his sentence.

Instead of giving him a longer prison term, the Chicago judge chose to free him, with the condition of serving a year while under house arrest in Hounslow.

The leniency of the sentence was attributed to Nav’s high level of cooperation with US authorities. He provided valuable insights into his spoofing techniques, aiding authorities in better detecting similar malpractices in the future. Additionally, Nav’s honesty was believed genuine by the authorities, which made them believe he was a person they could collaborate with.

However, what additional insights had they gained? Several questions were unanswered.

The first question that came up is: was it truly Nav that caused the Flash Crash? Andrei Kirilenko, a well-known economist who led the first investigation into the crash, didn’t think he was. He thought that Nav’s actions were not statistically significant enough to have caused the crash.

The second question that came up was: is spoofing a terrible thing? John Arnold, a well-known trader and hedge fund manager, presented an opposing view. He argued in a Bloomberg piece that spoofing served as a crucial counterbalance to the manner of high-frequency traders’, whose strong algorithms adversely impacted every other market participant. Spoofing helped relieve these effects.

Ultimately, the argument became debatable, since spoofing, together with the most terrible act of high-frequency traders, was prohibited – a direct consequence of the Flash Crash.

Once the issue was sorted, the question arose: was Navinder Sarao a villain or a hero? A lot of traders found inspiration in Nav’s story, and he was referred to as the “Hound of Hounslow” after Jordan Belfort from “The Wolf of Wall Street.” He was the small guy,  the David to the Goliath of hedge funds.

But, Mr. X, a trader involved in Nav’s detention, held a different view. To him, Navinder Sarao was merely a common criminal who had swindled both high-frequency traders and ordinary individuals out of their money.

Also, despite his nickname as the “Hound of Hounslow,” Navinder Sarao had not engaged in wealth redistribution like the present-day Robin Hood. According to Mr. X, Nav had simply pocketed funds for his benefit, casting doubt on his heroic status.

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

Navinder Singh Sarao, a genius in mathematics who is from Hounslow, London, built a reputation for himself by trading futures. Concerned with the automated high-frequency trading strategies he encountered, he made a computer program to outperform them. It achieved just that, albeit potentially contributing to the collapse of the global market. His deeds have left a long impact on the realm of finance.

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Savaş Ateş

I'm a software engineer. I like reading books and writing summaries. I like to play soccer too :) Good Reads Profile: https://www.goodreads.com/user/show/106467014-sava-ate

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