Flash Crash

by Liam Vaughan

  Before Nav joined IDT, he found he was able to play computer games for longer and with greater concentration than other people. He would wager hundreds of pounds a match on FIFA online, beating players in the top one hundred globally. That single-mindedness had some drawbacks. Nav was absentminded to the point of hazardousness. He regularly fell off the small, 125cc motorcycle he’d bought to drive to work, and was known to sit down and start trading with his helmet still on his head. But when it came to trading futures, Nav’s hyperfocus was a gift.

  Three years into his time at IDT, the distractions had increased. In 2005, after outgrowing its Weybridge digs, the firm had relocated to Woking, a less salubrious commuter town a few miles to the northwest. Paolo and Marco changed the company’s name to Futex and rented an entire floor of the Cornerstone, a hulking 1980s concrete-and-brick box on the same block as a public toilet and a boarded-up pub called the Rat & Parrot. They ramped up hiring, taking on two classes of ten people a year, and lowered the entry requirements for new recruits. The training programme was also condensed. Within a couple of years there were forty or so traders of wildly varying abilities and backgrounds panning for gold and racking up commissions from first thing in the morning until late at night.

  The office had a reception area, a breakout room, a kitchen and a classroom with a poster of Muhammad Ali. Paolo and Marco had their own offices. Everyone else sat on the trading floor, which was made up of a dozen or so rows of desks, divided down the middle by a walkway whose principal feature was a slightly sad-looking houseplant. The atmosphere ebbed and flowed with movements in the markets and news relayed through loudspeakers known as squawk boxes. It grew particularly febrile ahead of key economic announcements, such as employment figures, when Goldberg patrolled the floor shushing the trainees like an angry librarian. When the figure hit, the room exploded. The most experienced traders set the tone. Young, who by now wore flip-flops and board shorts to the office, had a habit of barking strings of Aussie-tinged expletives when things weren’t going his way. ‘I’ve done my fucking arse!’ was a particular favourite. One trader was evicted after punching a wall.

  Nav found all this negativity and posturing counterproductive. ‘You’d hear people say stuff like “I don’t want to be trading,”’ he later told a friend. ‘Those things make you demoralised. If you don’t stop them going in then they’ll have an effect on you.’ Nav believed his emotional state was critical to his success, and he guarded it fiercely. ‘You’ve got to make your mind strong,’ he explained. ‘A lot of people subconsciously take out their self-loathing in the markets. Make your self-esteem high. Make yourself feel like you’re deserving of the money!’ Nav’s solution was to extricate himself entirely, taking a desk by the toilets at the far end of the floor, three rows from anyone else.

  At Futex, the number of screens you had was a mark of honour. It was common for traders to have eight or ten, crammed with charts, news reports and flashing prices, as though they were guiding a spaceship. The thinking was that, by having a comprehensive view of the world, you would be able to make better decisions. Plus, it looked cool. As with so much else, Nav took the opposite approach. He stripped back his setup to just two screens, enough to fit the limited tools he needed to make money.

  By now Nav predominantly traded the S&P 500 ‘e-mini’, a futures contract that tracks the Standard & Poor’s 500, the bellwether index comprising five hundred or so of the largest companies on the New York Stock Exchange and NASDAQ. As the share prices of US businesses rise and fall, so does the S&P 500, distilling the fortunes of corporate America into a single figure. To coincide with US opening hours, Nav arrived at the office just before 2 p.m., when most people were returning from their lunch break, and logged off after 9 p.m., when it had cleared out. More than $200 billion of e-minis are bought and sold on the Chicago Mercantile Exchange’s (CME) electronic platform every day, and trading volumes in the contract far exceed the amount of buying and selling that goes on in the underlying stocks. It is among the most liquid markets in the world, used by banks, companies, hedge funds and asset managers to speculate on the prospects of the US economy or hedge other investments.

  Nav, like most traders at Futex, had very little interest in the outlook for corporate America, per se. He’d never visited the country, and he preferred reading football websites to the Wall Street Journal. He wasn’t an investor like Warren Buffett, seeking out undervalued companies by scouring financial reports and sales figures; and he wasn’t an economics expert, hypothesising over what the complex interplay of geopolitical events and interest rates might mean for the markets. His horizons were much shorter. Nav was what’s commonly referred to as a ‘scalper’, a trader who hops in and out of the market throughout the day, notching up small wins and positioning himself to clean up should there be a big swing one way or the other. At the end of almost every session, he made sure he had no outstanding positions – that he was ‘flat’, in the idiom of the trader. The next day he started afresh.

  The value of a single e-mini contract – the minimum one can wager – is calculated by taking the current value of the S&P 500 and multiplying it by $50. In mid-2007, when the S&P 500 was trading at around 1,500, a single contract, or ‘lot’, was worth $75,000. The market moves in increments of 0.25, known as ‘ticks’, and, regardless of the current price, every 0.25 move is worth $12.50 per contract (0.25 x $50). So if a trader buys 100 lots at 1,500 (at a cost of $7.5 million), waits for the price to notch up a tick, and then sells, she will walk away with $1,250. Of course, not everyone has $7.5 million sitting around, which is where brokers come in. Brokers act as an intermediary between a trader and the exchange. Even in extremely volatile conditions, the S&P moves around by only a few per cent in a day, so rather than requiring their customers to put down the total size of their position, they ask for a smaller sum, known as ‘margin’, which is calculated to cover any potential losses. Even so, losses can quickly mount up. As a result, futures markets are almost exclusively inhabited by professionals.

  At any moment on any financial exchange there are two live prices: the current selling price, known as the ‘best offer’, which is the minimum anyone is willing to accept; and the current price to buy, known as the ‘best bid’, which is the most anyone is willing to pay. The difference between the two is known as the ‘bid-ask spread’, and in the S&P 500 e-mini, where the volume of trading is huge, it is rarely bigger than a tick for long.

  To buy an e-mini on the CME’s electronic exchange, Globex, a trader must place an order, of which there are two main types. If she’s willing to trade at the current ‘best offer’ – let’s say it’s 1,500.00 – she’ll submit what’s known as a ‘market order’, and the transaction will happen immediately. However, if she wants to pay less, she can place a lower bid, at 1,499.00, say, and hope that the market comes down four ticks. This is referred to as a ‘limit order’. It can be cancelled at any time. Once the trader’s buy order of either type is executed, she is described as being ‘long’. To exit the trade, she simply sells the same quantity of e-minis, hopefully for more than she paid, after which she’ll be ‘flat’ again. A trader can also ‘short’ the market, or bet that the price will go down, by carrying out the process in reverse, selling some e-minis and then buying them back. (In trading, it’s possible to sell something you don’t actually own as long as you make good on it.)

  The single most important thing on Nav’s screens was a display called the ladder, which shows trades occurring and orders entering and leaving the market in real time. Also known as the central limit order book, it looks like an Excel spreadsheet with three columns whose contents are constantly shifting. The central column contains twenty price levels, ordered from high to low. They range from nine ticks above to nine ticks below the current ‘best offer’ and ‘best bid’. Next to each level is a figure showing the number of orders waiting ‘in the queue’ to trade at that level. Taken as a whole, the ladder provides an indispensable window into a market’
s supply and demand at any given moment.

  Adjacent to the ladder on Nav’s screens was a simple price chart that plotted the e-mini’s rise and fall, which he used to gauge the overall mood of the market and find patterns that might repeat themselves. ‘It’s a graphical image of people’s fear and greed,’ he explained to a trader who asked him why he monitored it so closely. ‘That’s what you’re trading, people’s fear and greed. And they repeat themselves again and again. If it’s an individual, some may have more greed, some fear. As a collective, everything rounds off to something you can measure.’

  The ladder shows trades in real time as they’re entering and leaving the market, offering an invaluable window into a market’s supply and demand. In this case, traders have placed orders to buy a total of 477 contracts at 2167.75.

  To some, staring at numbers and charts on a screen all day might sound dull, but for those who put in the time to understand its mysteries, the ladder can become highly addictive – a vast, confounding, ever-changing, zero-sum game played against some of the sharpest minds in the world for potentially limitless rewards. Every win releases a dopamine rush. Every loss is a blow. Adrenaline and cortisol course through the veins. In the words of Paolo Rossi, ‘When you’re trading, you’re alive’.

  Scalpers analyse the ladder for clues as to whether prices will rise or fall. To take the most basic example, if the total number of resting offers significantly outweighs the number of bids, supply would seem to outstrip demand and it might be reasonable to conclude the price will go down. However, there are myriad other factors to consider, including the speed with which prices are moving and the proximity of the resting orders to the best bid or offer. There’s also the question of who placed the orders and why. An international pension fund buying up e-minis incrementally over several hours as part of a billion-dollar transaction, for example, is likely to have a much more significant impact on prices than a bunch of speculative scalpers who are constantly placing and cancelling orders to earn the odd tick. Since all trading on the CME is anonymous, it’s impossible to know for sure, but good traders are able to build a sense of who they’re up against and react accordingly.

  To confuse matters, the bids and offers in the order book don’t necessarily reflect buyers’ and sellers’ true intentions. Rather than entering one huge bid and tipping the world that it’s in the market for e-minis, the aforementioned pension fund would likely break up its order into small chunks, perhaps using a feature available on the CME called an ‘iceberg’. Another trader might try to create as much noise as possible, entering more bids into the ladder than he really wants filled, with the goal of enticing opportunistic traders to join him and push the price higher. Like the red-jacketed locals in the pits, he is seeking to use his perceived bulk to boss the market around. This perpetual gamesmanship helps explain why nine in every ten orders placed in the futures markets were cancelled before they could be filled.

  In the same way poker players try to deduce their opponents’ hands from their betting patterns or the twitch above their left eye, traders will use pattern recognition and statistical analysis to fill in some of the gaps in their knowledge. Fifty offers keep appearing on the sell side of the market exactly ten minutes apart? Maybe it’s an algorithm that can be exploited. Someone keeps placing bids of 139 lots? Perhaps it’s a complacent day trader who hasn’t bothered to mix up his order size. With hundreds of market participants active at any time, the permutations are endless. Like a jazz musician who’s learned his scales and is now free to improvise, Nav was able to subconsciously evaluate the ladder and perform complex calculations in real time. The last twelve times I saw the price move this way, this other thing happened 85 per cent of the time. I’ll buy. The lightning-speed mental arithmetic that had amazed the Rossis during his interview kicked in, and with his left hand hovering over his keyboard and his right hand on the mouse, he bought and sold futures at an astounding rate. ‘I know it sounds ridiculous, but he was like one of the robots in West World or Neo from The Matrix or something,’ recalls Leif Cid, who spent time at Futex in 2007 and 2008. ‘He didn’t just observe the market. He was inside it’.

  Four years after joining Futex as a novice, Nav had built up a bankroll of $400,000 and acquired something of an aura around the trading floor, where most didn’t survive a year. On a good day he would make $20,000 or $25,000 before casually yanking off his ear defenders, putting on his helmet and driving his wobbly motorbike back to Hounslow. New recruits were told to watch out for the quiet guy with the beaten-up brown leather jacket who arrived at 2 p.m. each afternoon to trade the US market from the back of the room. They crowded around the risk manager’s computer to rubberneck at the size of his positions. While they were flailing around with one and two lots, Nav routinely staked hundred-lot orders, representing more than $7 million of his broker’s funds. At that level, his account rose and fell by $1,250 each time the e-mini moved a single tick. Every few hours, Nav stood up and bounded over to the kitchen, where he filled a jug with milk and drank it straight from the lip like a ravenous animal. His colleague Cid and his luckless friends would follow him in and ask what he thought about the markets that day. Nav tried his best to impart some wisdom, but much of what made him special couldn’t be taught. Cid hung around anyway, ‘as if by osmosis it would rub off on me’.

  Some of Nav’s decision making was perplexing to the other traders. One of the first lessons they’d been taught about placing a trade of any size was: always use a stop-loss. A stop-loss is a standing instruction to automatically buy or sell once the market reaches a certain threshold. A trader buying e-minis because he thinks the S&P 500 will rise, for instance, might place a stop-loss at twenty ticks below what he paid to limit his potential downside. It is widely considered an essential tool to avoid catastrophic losses – a safety net to ensure that, should the bottom fall out, you won’t plummet to your doom. Nav shunned them, saying he preferred to ‘let it breathe’. That philosophy, while highly risky, meant that trades veering into losing territory had the opportunity to reverse course. If Nav had a high degree of conviction about a position and he didn’t want to be put off by moment-to-moment fluctuations, he would leave his desk and start yanking himself up and down on a pull-up bar he’d fitted in one of the doorways. Other times he could be found lying on the sofas by reception playing the football management game Championship Manager on his phone. ‘You’d go over and say, “What the fuck are you doing? The market is going crazy.” And he’d say, “It’s my time analysis,”’ recalls Josephides. ‘Nobody knew what the hell “time analysis” was, and it became this running joke: Nav’s doing his “time analysis” again.’

  From the start, Nav pushed for more capital to trade with. Whenever he hit a new milestone, he would stride down the walkway to Marco’s office, close the door and demand higher risk limits. For the Rossis, it was something of a bind. On the one hand, Nav was one of a handful of golden geese. The money he generated through the profit-split arrangement was enough to fund a dozen new recruits. On the other, they didn’t want to give Nav enough rope to be able to bring down the entire firm. Usually they found a compromise, but not before Nav told Marco what he thought of him loudly enough for half the trading floor to hear.

  The lack of stop-losses, the huge positions, the ‘time analysis’ – they were all symptomatic of another element of Nav’s makeup that elevated him above the crowd: a near-total imperviousness to risk. His attitude didn’t change if he had taken a position of one lot or one hundred. If a trade was right, he reasoned, it was right, so there was no point in holding back. ‘If you don’t care about the money it’s a lot easier,’ he later told a friend. ‘Look at it like a computer game; you’re playing to win but it’s a bonus if you get paid. If it wasn’t fun I’d have stopped doing it.’ There were days Nav lost tens of thousands of dollars and nobody on the floor had any idea. Traders who lost a fraction of the sums he did would curse their luck, berate the irrational morons in the market and tel
l sob stories for days. Some shut down their computers, ashen-faced, and never traded again. But Nav’s demeanour barely changed. It was as if the caveman part of his brain, that primal instinct to guard what he’d gathered at all costs, was missing, freeing him up to put it all on the line again and again. ‘The way I see it is, I haven’t lost an arm or lost a leg,’ he rationalised. ‘You’re never getting them back. Then I’ll be crying. But I know I can make the money back tomorrow, or if not tomorrow, I can get in my head for two or three months and make it back. Why worry about losses? Everyone loses, bruv. You’ve just got to deal with it.’

  Nav’s swashbuckling exploits in the market stood out because they were so at odds with the way he lived his life. He barely withdrew anything from his trading account to live on, preferring to let it accumulate like a high score. He’d long ago ditched his ill-fitting work attire in favour of tracksuit trousers and cheap sweaters that he wore for days on end. For lunch, or, more accurately, dinner, he ate supermarket sandwiches or a Filet-O-Fish from McDonald’s. He barely drank, didn’t smoke, had no love life to speak of, and when the rest of the office decamped to O’Neill’s pub every Friday, he stayed behind to continue trading. One Christmas, Futex took the team to a well-known nightspot in central London. Nav was refused entry because, despite repeated reminders to dress up, he arrived in his trademark yellow Fila-branded sweatshirt and trainers. Eventually, he snuck in and spent the rest of the night hiding from the doormen. For old-school traders like Paolo, who proudly displayed their success, it was bewildering. What was the point of making all that money if you were never going to spend it?