This is a comment on the story rampant in the press about a British Man causing the US "flash crash". If you are not familiar this is as good a background as needed.
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
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.
John
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.
J
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.
If you have a half decent algor you should be able to eliminate the noise of spoofers in the order book, especially when his lot size is always the same.
ReplyDeleteNot sure how different the computers trading ahead of a big order are from locals who would do the same on the floor though? Just faster version of the same thing. Always been people try to read order flow and go with it or get ahead of it
"PPS.Navinder Singh Sarao is a kid because he operates out of his mum's basement"
ReplyDeleteFrom that Telegraph link you posted.
"Neighbours of Mr Sarao in Hounslow, west London, said he was married with two children and lived quietly in a house opposite his parents’ home, where his company Nav Sarao Futures was registered. "
Disproves your "Mother's basement" statement...
Hope you'll be contributing to your hero's defence fund?
ReplyDeleteI probably will contribute to his defence.
ReplyDeleteDoes it matter if there are lots of spoof orders in the market as a long term investor? I don't care what the intention of a order is, if it is there to execute it is a real as any other order.
ReplyDeleteThe natural limiting factor to spoofing is liquidity takers.
"Neighbours of Mr Sarao in Hounslow, west London, said he was married with two children and lived quietly in a house opposite his parents’ home, where his company Nav Sarao Futures was registered. "
ReplyDelete...I think it turned out to be his brother living across the street. He still lived at home.
This kid in his parents basement had stashed $40 million in accounts in asset-protection/tax-haven jurisdictions.
ReplyDeleteYour post confuses front-running, when a broker trades ahead of their customer, with ordinary technical trading that tries to anticipate short-term trends. Should that be banned in HFT for? Maybe, but it's current legality doesn't excuse someone committing a different form of fraud.
The suggestion that spoofing fights HFT is horseshit. Spoofing is one form of improper HFT. These bids didn't target HFT (he wasn't fast enough) and they weren't on just for milliseconds.
He also knew what he was doing was wrong-he lied to the software developer about it and then lied to his brokerage about it.
And he was caught when the brokerage filed Suspicious Activity Reports.
And there's nothing high-tech about this fraud. It's not different from "painting the tape," inserting bogus transactions into the stream that gets reported to other traders and the public. This is the digital-order-book-visible form of painting the tape.
The enemy of my enemy is my friend?
ReplyDeleteOr is he rather another form of enemy?
Perhaps the real problem lies with a market which enables spoofers and front runners to operate with an advantage over other market participants?
Might it not be better to slow the market down, so that it operates in, say, seconds rather than milliseconds? Thus removing a lot of the advantage front-runners have.
Spoofers don't make the market safe from front-runners - the front-runners make a lot more than they do. So perhaps instead of acting as heros making the market safe for you, they are more akin to a virus on a leech?
I've often heard people suggest a small transaction tax as a way to put a damper on HFT and similar shenanigans, but I like your idea of a small order tax better.
ReplyDelete"Disproves your "Mother's basement" statement..."
ReplyDeleteDisproves the strict sense but not the general point - houses in Hounslow don't have basements because the land values don't (or didn't) make it worth it. Like having a skyscraper in Montana - why bother? But he does look strictly small time - the judge queried why someone who had made £25 million (per CME's case) was living in Hounslow.
Very good comments.
ReplyDeleteI think there is already a good means of limiting excessive spoofing. Anyone spoofing is likely doing it with a ton of leverage. Even "spoof" orders can get filled by legitimate market orders for size. A spoofer then could end up long/short with a ton of leverage after a real money guy took a few prices of liquidity.
That being said I think most traders understood spoofing and really only look at whats being traded.
The real market manipulation that needed eliminated was the excessive order entry with the intent of crashing the exchange. At that volume they were all done by algos and this has occurred where an algo tried to crash the system and then trade the dislocated prices that resulted. Normal spoofing doesn't cause that and as a trader I think spoofing is highly dangerous as a strategy. Picking up nickels with the risks of getting lifted into a sudden event.
Any market maker, whether computer or human, will respond to order book balance when making a market. If they didn't they would be routinely run over by large orders and lose money. To make a tight market requires cancelling some orders, though those orders were real orders when placed. To not reprice (cancel some orders) when the book balance changes is tantamount to giving money to those placing larger orders. If you cannot cancel orders, then you cannot make a tight market.
ReplyDeleteWhile it is ludicrous to suggest this guy caused the crash, it appears as though he created algos whose purpose was to automatically cancel orders so that they could NOT be filled. Said orders were merely a diversion to other traders. In other words, they were never intended to be real and are thus fraudulent.
How is it good for the market to make it legal to post fake liquidity? Why do you assume that all HFT market makers are frontrunning computers? Human market makers are dead. If you allow spoofing, markets will trade wider and liquidity will be reduced--as will the usefulness of all information in an order book. Would wider spreads also be good for investors? Because that would be the result.
How does it make sense to contribute to his defense when you have said that spoofing is illegal?
ReplyDeleteHe broke the law.
Are you saying that the law should be changed, or that prosecutors should ignore this law? Or do you just want to see him to get a lenient punishment?
yeah im sure one guy caused the flash crash, they must think we are all idiots to believe this nonsence
ReplyDeleteSpoofing requires big size to be effective;
ReplyDeletebig size requires big money ;
give a free rein to spoofing and the markets will become (or remain) a monopoly for the biggest guys .
If there is a concern about front running , use an iceberg .
Preferably , "show your size and be a man , if you want to trade in a man's market" (with credits to Tony la Porta). At the end of the day , size attracts size .
IMHO Nav did nothing wrong .he took massive risk , and barely got rewarded.
I would rather have a delay on cancellation than a Tobin tax.
And another thing...is it so bad to have some sort of ID s attached to trades ; the fraternity would have taken alot less than five years to work out why the flash crash happened if offers and trades had had IDs of some sort attached to them
best nickindubai
So I'm standing in front of a grocery store yelling at everyone "MILK FOR SALE $100/litre 100 LITRES MINIMUM ORDER, I'VE GOT TRUCKLOADS OF MILK, COME AND GET IT!!!!" and then people start frantically selling the milk in their grocery bags to others on the street for dimes, umm, not really understanding how their madness is remotely my fault. That's just a shitty algorithm. I should be allowed to offer Milk at that price. (Can't he just argue that we would have been happy to fulfill any of his spoofing orders, since they would have been instantly in the money?)
ReplyDeleteTo blame the ills of the system on a stray trader is the limit of an oppressive regime. Surely, the folks at the exchange should be able to guard against the designs of a single isolated 30-something.
ReplyDeleteTheir actions suggest that there is some behaviour that is enabling big moneybags to milk the system. That behaviour is off limits for commoners and they want to keep it that way by any means. London trader's only fault seems to be that he figured out that behaviour and used it to his advantage.
pnovice
The point is that HFT is already using these types of techniques (including momentum ignition, spoofing, etc.) to an even greater degree, and they get away with it. This guy's actions was basically like a shark eating another shark. Only issue is that he's not as politically connected as typical US-based HFT firms.
ReplyDeleteWouldn't living in London be too far away from the US exchanges to be able to mix it up with HFTs?
ReplyDeleteThe govt highlighted in Ex A of the complaint the trading session on 5/4/10 from 11am to 11:12am. I trade SPY and I was curious what effect this had on SPY for this minute period. The answer is none, in fact SPY reversed slightly while the S&P 500 mini was ratcheting down. It makes Ex. A hilariously funny. I find it difficult to believe that Sarao with his modded software is even a key villain in the Flash Crash and I can only agree for now he is a red herring. Any thoughts?
ReplyDeleteJohn Arnold has written a Bloomberg article supporting your argument here http://www.bloombergview.com/articles/2015-01-23/high-frequency-trading-spoofers-and-front-running .
ReplyDeleteAlso, the FT’s Paul Murphy is not mincing his words here http://ftalphaville.ft.com/2015/04/22/2127319/saving-trader-sarao/ saying “…the reality here is that the futures markets – in London as well as Chicago – are riddled with manipulative trading, and the authorities really don’t know what to do about it.” He points to the case of Igor Oystacher.
Further, I think spoofing is illegal now but not when the flash crash happened.
Ian Bright
…and I can’t resist noting John Cochrane’s blog post http://johnhcochrane.blogspot.nl/2015/04/just-when-you-thought-financial.html . “Just when you thought financial regulation couldn’t get more expansive and incoherent, our Justice Department comes in to defend moron’s right to herd.”
ReplyDeleteIan Bright
I work in the markets doing fundamental research - similar to John but not anywhere near as experienced. AND I have just finished the excellent Flash Boys by Michael Lewis.
ReplyDeleteOf course, this now makes me think that I am a complete expert on all things HFT!
My conclusion from reading the book was that there is some very very serious money being made by HFT and it is enabled by our fricking Prime Brokers and others. The very concept of best execution is clearly alien when your HFT client gets his cheque-book out.
My second conclusion is that this is fiendishly complicated. So complicated that it would be essentially impossible for someone in law enforcement to have a true understanding about what is really going on.
It took Brad Katsuyama literally years to get close to understanding and he was a real market participant being advised by the guys who wrote the code.
And from the prosecution of Sergey Aleynikov as well as the abhorrent treatment of David Einhorn by the SEC described in his book (NOT the Punch stuff - that was sketchy) we know full well that the idiots mounting prosecutions just don't have a clue.
As this relates to Mr Sarao, he may well have been busy spoofing during the flash crash - I am sure his easily verifiable trading history and order history can show that.
However, the notion that he wiped billions off the market and netted £588k yet was "at least significantly responsible" for the flash crash is utterly laughable.
Aitan Goelman is clearly a complete moron.
I am not sure I understand spoofing well enough to tell whether it might counter the abhorrent HFT front running activities but it is nonetheless illegal so Mr Sarao might get done for that (ONE charge) however, the charges of wire fraud and market manipulation could be much harder to prove.
Also, the suggestion that he was "extremely active" in the market ahead of the flash crash just shows how ignorant these guys are.
Aitan Goelman will go down in history as yet another regulator prosecuting the WRONG PERSON.
Ive been reading quite a bit of nonsense written over the last 24 hours about the Navinder Singh Sarao “Flash Crash” story, mainly in the tabloid press, but thats to be expected. I suppose they would buy into the line, that this little guy in Hounslow could do so much damage to a $20 TRILLION market with an off the shelf algo, because that is what they are being spoon fed.
ReplyDeleteMaybe they should ask themselves if this dude can do it, then why hasn’t Putin’s Russia, ISIS, or Iran, North Korea, the Mafia, or anyone with either a political or economic interest in destabilising the market, already had a crack at it. ( Im sure Navinder’s services are in demand!!)
Anyway I will leave my opinions to the side and quote yesterdays FT leader “ You cannot spoof half a trillion dollars off the value of US equities.To accuse Mr Sarao of causing the crash is like blaming a flea on an elephants rump for causing a stampede".
From the FT it seems that Mr Singh Sarao was using an ago to spoof and layer the market. This algo would fire in multiple orders above and below the market, and he used a "cancel if close” function or a cancel if there wasn’t “x” amount of orders in front of him.
Now according to the FT, the CME noted his unusual trading patterns in 2009 and in 2010 contacted his broker to alert them. Allegedly he was told that his conduct was not allowed. So my first real big issue is: Who was the clown at the CME who decided to continue to allow this disruptive and manipulative trading to continue? What there a high level decision to permit this to continue in some misguided belief that this liquidity he was providing was good for the market? If this was the case, i will give you a clue…. HE PULLED THE ORDERS WHEN THEY GOT CLOSE!!!! he provided little or no liquidity.
Heres my second issue. Mr Sarao was using these layering and spoofing techniques, sending orders out intending to cancel. and bring profits by the resulting market movements. According to the US DoJ “WHEN PRICES FELL as a result of this activity, Sarao allegedly sold futures contracts only to buy them back at a lower price”
So lets think this one through… Sarao offers a load of Eminis in a flash which get cancelled, but somewhere out there a computer program or programs sees his orders for a millisecond and offers or sells in front of him, driving prices lower. Sarao who is already short covers his position.
This is the point where i am getting really p1ssed off. The DoJ and all the other regulators seem to think that the problem is the guy spoofing the market and putting in the phantom orders. WRONG. The real problem is the computer driven HFT algos which add no value or liquidity , but seek to sniff out real orders and front run them. This is happening every day on every exchange or virttually every order. Retail and Institutional investors are getting stuffed every day by these (and i don’t use the term lightly) …..Vermin
This case brings into question what exchanges are for and how they should work. Should an exchange be a utility that sets the highest standards of market conduct and gives ALL of its users confidence that they are being treated fairly. Or should an exchange favour one group of users (HFT) over another because they pay more in fees?
Do we need 50 exchanges for instance in the US with orders being broken into bits and sent out in all directions to multiple venues. Wouldn’t real liquidity, price discovery and tighter spreads be better served with transactions taking place on one market?
Does anyone other than a HFT trader need an order executed in a millionth of a second?
I think this case will throw up a lot more pertinent questions in coming months.
Couldn't agree more John - it's an absolute disgrace. Hope the UK does the right thing and dismisses the request from the US government.
ReplyDeleteThank you for speaking out about this.
ReplyDeleteIt wouldn't surprise me at all to find out that an HFT filed the whistle blower case that got this legal action started.
A small time successful spoofer is being made an example of while Citadel and Virtu make hundreds of millions every year.
Couldn't agree more
ReplyDeleteGreat!
ReplyDeleteAgree with you. And I hope the U.K. stands up for its citizen!
Insiders such as market makers, so-called internalizers (such as IG Index), HFT guys etc. use computers that chase a retail trader's bid or offer and immediately it is filled, move the market in the opposite direction. I have experienced this with the S&P500, Dow, FTSE etc. One will imagine that these indices cannot be manipulated , but they are manipulated intraday by insiders all the time. I don't see what is wrong if a retail trader tries to outwit them. It seems the game is so rigged that only the insiders are allowed to manipulate.
ReplyDeleteI thought that the purpose of market makers was to ensure price discovery is orderly. How come the market makers were not able to prevent a single guy with a not too powerful computer from causing disorder in the markets. If the Emini does not have market makers, then whose fault is it? Sarao is INDEED A HERO!!!
And there was Robert Harris in "The Fear Index' telling us it was all down to a sophisticated artificial intelligence programme constructed by a genius hedge fund manager. Although the fact that somebody who prides themselves on their research had such an obvious howler that Accenture went to 1c because the computer went short ACN whilst going long Deloitte, err an unlisted company, still annoys me.
ReplyDeleteIt seems a couple of very simple changes can drastically diminish the prevalence of HFTs by increasing its effective risk:
ReplyDeletea. As you mentioned, charge a modest fee for placing orders, to be rebated if the orders actually execute
b. and/or make orders non-cancellable for at least 5 seconds after placement.
Of course, another problem is that in equities trading, all these venues compete against each other for volume... and volumes (and hence revenues) come from the HFTs. So the venues actually compete to attract as many HFTs as they can... it's quite ridiculous.
I don't know if this guy is a hero but he is within his rights to post whatever he wants. If you are buying spx contacts hopefully you are doing it because you find value at your bid level. The paranoia over HFT is such nonsense. I have yet to hear a clear explanation from someone who claims they were harmed by HFT. Meanwhile, spreads and liquidity and costs are so much better now than ever before.
ReplyDeleteThe Times in London has had a number of articles recently that have questioned the US case against Nav Sarao and John they mentioned your support recently in the Sunday Times. Today they are reporting that the reason he has been unable to raise the 5 million GBP bail and remains in custody is that the US has obtained an order freezing his worldwide assets and the Caribbean banks where he had stuffed his gains (the account is Nav Sarao Milking Markets Ltd!) are afraid to violate it. He might have been wiser to keep it in the UK.
ReplyDeleteThe is so bullshit reason of arresting a guy trading at home saying he caused 1 of the biggest 1 day crash in the history of usa. If this would have been the case a crash would have occured everyday caused by some hedge fund who have billions of dollars to trade for their advantage.
ReplyDeleteI dont know about the crash But this is a silliest reason to arrest a person in the history of the world.
There are two things, if implemented correctly, could solve both issues of spoofing and high frequency trading.
ReplyDelete1) Every order should stay for at least 2 seconds before it can be redacted.
2) Enforce strict margin requirements.
I picked two seconds as an arbitrary time. But in theory it could be any reasonable number.
What do you think?
I disagree strongly with the idea that every order should stay 2 seconds before redaction.
ReplyDeleteComputers would still front run me. I have no problem with liquidity someone will provide IF I CAN HIT IT.
I actually want the opposite. I want to legalize all forms of high frequency trading.
SPOOFING is good for us. It reduces the abusive kinds of high frequency trading.
J
A small time successful spoofer is being made an example of while Citadel and Virtu make hundreds of millions every year.
ReplyDeleteads in USA
local USA classifieds
Interesting comments. I am learning a lot here. Little old me tried a demo SB account and turned £10k into £260k within a very short period of time. Wonderful I thought, until I tried it for real and I'm over 60% down within 2 weeks of trading. I also notice that more often than not everytime I think I'm placing a sure trade, long or short, the market almost instantly starts to move against me! Granted, I may be completely rubbish at trading. I have also learnt about OTC and DMA, which also tells me that any retail investor/trader like myself stands no chance, even with DMA if there are all these HFTers and spoofers. Surely any automated system that is working in milliseconds is going to out price and outwit a human executing manual trades?
ReplyDeleteAll this is telling me that the only thing I can do is good old fashioned long only stock picking. Unless someone can tell me otherwise? Everything else seems to be purely up to chance with a higher probability of losses than gains.
Anyway, I thought you guys would like to know the latest on Mr Sarao:
http://www.bloomberg.com/news/articles/2016-01-27/hound-of-hounslow-s-flash-crash-blame-questioned-before-hearing
PS noone mention his company name? Milking Markets Ltd?! that brought a smile to my face.
Oh and I thought you guys would also be interested in this story:
ReplyDeletehttps://www.fca.org.uk/news/fca-fines-us-based-oil-trader
The irony within it is almost laughable. It seems like you can't beat them, so therefore the only option is to join them, if at all possible.