Thursday, April 23, 2015
Navinder Singh Sarao: Our spoofing hero
It took me a while to get my head around just how ludicrous the assertion that a kid (Navinder Singh Sarao) trading a few thousand e-mini contracts caused the "flash crash" was. He did this every day for a few hundred days - and almost every day there was no flash crash. Then there was a flash crash - so ergo - a kid in his basement caused it.
He did this by "spoofing" which is an illegal form of market manipulation. If you need a summary beyond what I give here Matt Levine provides a fairly good summary.
Spoofing - so what is it? Its placing a bunch of (say) sell orders a little above market and a smaller buy order a little below market.
What then happens is that "front running computers" see the multitude of sell orders and assume they are real. They then decide to sell some to get in front of some real selling. The real buy order gets executed.
Now our spoofer is long. They will want to sell at some stage - so they reverse the process. They place a lot of buy orders a little below market and a smaller sell order they want executed - and the front running computer crosses the spread.
The spoofer thus earns the spread, they do this repeatedly and the loser is front running computers. All these trades are placed for mere milliseconds so spoofing is one computer ripping another computer off. Real people don't get fooled by spoofers because the spoofed trades are around for milliseconds.
Making spoofing illegal thus increases the profits of front running computers - meaning more front running computers.
Now alas when I buy a real order in market I have to pay my due to the front running computers - which comes at a real cost to me - a real investor - and to my clients. This is a real cost to real investment in the capital market.
I would prefer the front running computers go away - and the best way for that to happen is to allow spoofing. Spoofing makes the world unsafe for front-running high frequency traders.
So what have the regulators done. They have arrested a kid who is spoofing the market with a few thousand e-mini contracts and hence taken money from the front-running computers whose real goal is to rip you (real investors) off. They have made the world safe for the conventional high-frequency traders at a real cost to the investing public.
They were helped out by an industry whistle-blower.
In other words they did it with the help of an industry participant: someone who runs the front-running computers designed to rip-you off.
The Department of Justice has been played into bringing the full force of the US legal system onto an irrelevant trader - just to make the world safer for the real rip-off merchants.
And their case looks plain silly.
As for the kid - Navinder Singh Sarao - he isn't a criminal. He is a hero. He is the sort of guy who makes the market safe for ordinary investors.
Here is to hoping the English judge treats the extradition request with the contempt it deserves.
Post script: This post caused some debate in our office. Two objections were raised.
(a). There may be some real investors who use algorithms to "just get the trade done". There is an algorithm like that available on interactive brokers. A "just get it done" algorithm may also front-run a spoofer.
(b). If you allow spoofing you would wind up with enormous quantities of it. It would get to the point where maybe 99.9 percent of offers in the market - especially ones just outside the money - would be spoofs. This could be solved with a very small fee - reflecting costs - for placing an order. The fee would probably need to be less than 1c per $100,000.
Neither of these objections however undo the main argument which is
(a). Spoofing makes profits at the expense of front-running computers.
(b). It thus will reduce the number of front-running computers.
(c). Front running computers make profits at the expense of real investors including our clients.
(d). Therefore spoofing helps my clients and I like it.
Navinder Singh Sarao really is a hero.
PPS.Navinder Singh Sarao is a kid because he operates out of his mum's basement. He was really in his 30s - but that is still a lot younger than me.
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