'Flash crash' allegations raise some troubling questions

I’ve been reading through the list of charges laid against Navinder Sarao, the trader who American authorities are trying today to extradite to the US.

He is accused of manipulating a relatively obscure market traded in Chicago in such a dramatic way that the effects snowballed through to knock share markets in New York and beyond, temporarily knocking a trillion dollars off the value of American companies.

All of this from his rather ordinary semi-detached house near Heathrow Airport, outside London.

The US regulator, the Commodities and Futures Trading Commission (CFTC), alleges Sarao adapted a computer trading programme so that he could manipulate the price of the E-mini S&P 500 Futures contract and then, knowing which way that contract was going to go, bought or sold off other, unsuspecting traders and made a huge profit. Around half a million dollars a day, says the CFTC, and around $40 million in total.

The civil case laid out by the CFTC alleges Sarao created "layers" of exceptionally large orders for contracts which were just below the active price in the market at the time.

Other traders could see these apparently impending orders to sell huge sums and their computers anticipated a consequent fall in the market price, so started to sell their own contracts.

But as the market price moved closer to Sarao’s orders, his computer automatically whipped them away, cancelling the orders and replacing them with new orders a little lower still. Other traders followed suit, again selling their contracts and pushing the price ever lower.

At this point, Sarao is alleged to have stepped in and bought the contract at a cheap price and made a profit when he switched the algorithm off and the price returned to its natural level.

The sums alleged are extraordinary. On each day he used the trick, he is thought to have put in orders of $7.8 billion (yes, billion) dollars making up as much as 40 per cent of all the “sell” orders on the market that day.

It’s perhaps no surprise, then, that investigators say they can spot the market dipping each time the computer algorithm was switched on and then rebounding when it was switched off.

He is alleged to have played a part in the “Flash Crash” of 2010 but carried on with these misleading and fraudulent trades for at least four years.

Even after the exhaustive evidence in the affidavits supplied by the American authorities, there are lots of questions, not least: why did it take them five years to spot such apparently obvious tactics? And if they caught one man who was able to do this by tinkering with commercially available trading software, how many more rogue traders are there? And how did the big institutional investors get duped? The case, as they say, will continue.