Flash Crash

by Liam Vaughan

  The post went on to suggest that traders should consider boycotting the e-mini to force the exchange to take action before concluding:

  I’m half thinking of asking CME directly how I can get the equivalent software which allows you to spoof without being hit, because I do a fair volume myself, but I feel it would be wrong. THE MARKETS SHOULD BE ON A LEVEL PLAYING FIELD FOR ALL.

  Fugazi’s language was less combative than in his earlier posts, but still nobody replied. Four days later, he posted an update:

  Oh one final caveat. I am working on a program on TT[fn1] to get the exact same cheating software. If you cant beat em you may aswell join em eh? Europeans have a pathetic attitude of accepting whatever authority throws at them – they never fight back. With the volume I do I know the exchange will turn a blind eye. And just imagine how easy trading will be since one is already cleaning up whilst playing by the rules. Tis been a sweet week.

  There, on a popular public forum, Nav laid out the seeds of a plan that eight years later would culminate in his arrest for manipulating the market and helping cause one of the biggest intraday financial crashes in history. If anyone was paying attention, they might have been able to talk him out of it or notify the authorities. But, like the boy who cried wolf, he’d run out of credibility, setting him on a path disciples of Elliott or Gann might suggest he was destined to travel.

  CHAPTER 6

  END OF AN ERA

  On a spring afternoon in 2008, traders at Futex returned from lunch to find Nav leaning back in his chair with his hands behind his head. For hours he didn’t touch his computer. A rumour made its way around the office: ‘He’s on strike.’

  After five years, Nav had fallen out of love with Futex. He was fed up with the schlep to Woking and the distractions that awaited him when he got there. He was tired of begging for bigger limits. But most of all, he was sick of giving his money away. When he joined the arcade, he’d signed a contract agreeing that, in exchange for Futex staking him, he’d give up a share of his profits, a monthly desk fee and a commission on every ‘round-trip’. The profit split started at 50/50 and went up on a sliding scale depending on how much he had in his trading account. Now that Nav had accumulated more than £1 million ($1.6 million) he was entitled to 90 per cent of everything he withdrew, the maximum available.

  For fledgling traders, Futex was an attractive proposition. They were given capital to try their hand and didn’t pay anything back until they were profitable. If they failed, as most did, they could walk away owing nothing. The flip side was that those who did make it subsidised everyone else. By now, Nav was routinely earning $50,000 a day, which meant giving $5,000 to the Rossis. And, with his frenetic style of trading, he could easily hand them an additional $2,000 in commissions. ‘A lot of these people, it was their first job, just out of uni, twenty-two, twenty-three years old,’ says one former trainer at Futex. ‘They keep them very much within those four walls, and because they’re down in Woking they rarely speak to anyone else within the City. But then they speak to other prop houses and realise what a shitty deal they have.’

  Nav’s 90/10 split was generous by the standards of most other traders on the floor, but he wanted 95 per cent. When the Rossis refused, he shut down his trading software knowing he’d be severely crimping the company’s cash flow. It was the culmination of a feud that had been escalating for a while. A couple of years earlier, Nav had decided to quit trading FTSE 100 futures, the UK equivalent of the S&P 500 e-mini, where he was regularly making £2,000 a day, to try his hand at some bigger markets. After a shaky start, Paolo took Nav aside one day and suggested he go back to the FTSE. ‘Five hundred grand a year, that’s more than enough for you,’ Rossi said.

  ‘How do you know what’s enough for me?’ Nav replied, incensed that Paolo of all people would try to clip his wings.

  On another occasion, Nav had gone home one night after placing a two-hundred-lot trade. The next morning, he was woken up by a call from Paolo telling him he’d lost a million dollars, virtually everything he had, he would later recount to a friend. Nav was shocked. ‘Just get me out,’ he said.

  ‘Nav, calm down,’ Paolo chuckled, according to Nav’s recollection, ‘you’re a hundred and twenty ticks onside!’ Nav’s overnight trade had earned him hundreds of thousands of dollars. ‘This is a lesson for you: always have a stop in the market. One of these days something like this will happen and you’ll get rolled over.’

  It was an incredible result, but Nav couldn’t get past Paolo’s attempt to scare him into exercising better risk management. When he arrived at the office, he remembers marching into the owner’s room and shouting: ‘Are you still gonna take my money after that little escapade? Putting me through that and then charging me two hundred thousand dollars for it?!’ Nav was on an 80/20 profit split at the time. ‘What a wanker,’ he complained to the friend. ‘The guy’s got no shame.’

  It didn’t help that Paolo was so blatant about how much money he had. Futex’s website had a page titled ‘Futex Lifestyle’, which could more accurately be described as ‘Paolo Rossi Lifestyle’. There were photos of Rossi at the Wimbledon final and watching Champions League football. Once, when his Ferrari had come back from the garage and the Lamborghini he’d been given as a replacement hadn’t yet been taken away, he posted a picture of them both with the caption ‘some tough choices’. One of his cars had the licence plate R9ssi and he was a member of Queenwood, one of the UK’s most exclusive golf clubs, where he shared the fairways with Hugh Grant, Catherine Zeta-Jones and golf pro Ernie Els. ‘All that material stuff is pointless and attracts the wrong people,’ Nav said to his colleagues with disdain. ‘Trust me. It’s a mirage.’

  But Paolo wasn’t the only one displaying his success. In August 2007, a magazine called Trader Monthly published its annual ‘30 Under 30’ list of the most successful young traders. It included the following entry:

  Legend has it that just outside London in the small, affluent city of Woking resides a pure prop trader who works two hours a day, two days a week – and still makes twice as much as anyone else at his clearing firm. The legend, it turns out, is true – and that gifted trader has the 30 Under 30-appropriate surname Young. ‘He wears jeans, his lucky jersey and no shoes,’ says one colleague. ‘He even puts on trades and sleeps at his desk.’

  [Bradley] Young, an Aussie who spends more time on vacation than he does trading, has been known to pull down $250,000 a week even after the bosses at Futex exact their tribute …

  Says Young: ‘From the very first day I traded a futures contract, I’ve always believed that I was going to be one of the greatest traders of all time. As each day passes and my career progresses, this belief becomes stronger.’

  Trader Monthly was launched in 2004 and quickly became popular on trading floors around the world, mixing profiles of Big Swinging Dicks with articles on classic cars and how best to disguise one’s strip club receipts when claiming expenses. Like its readership, it was male, crude and brash. But the ‘30 Under 30’ feature took off and was frequently picked up by the mainstream press. CNBC interviewed inductees like they were celebrities. For Brad to be anointed was major kudos, even if the stuff about him barely turning up to the office was untrue.

  A couple of months later, Nav emailed the editor:

  Good evening,

  I have recently been introduced to your magazine and must congratulate you, since it is one of the better publications I have seen on the art of trading. I read with interest your top 30 under 30 list and was wondering what criterion someone would need in order to be part of it. I am a local who works on a 90/10 split. I trade the e-mini SP 500 and on volatile trading days I do on average 10,000 round turns or about 1% of the SP 500’s total daily volume. If I trade well on a volatile day I normally make circa $133,000. On quiter [sic] days I look to make between $45,000 and $70,000.

  It’s been an extraordinary year in my trading career. You must understand that for me to be in the top 30 is not a van
ity thing. I prefer to keep a low profile and indeed hide my P&L’s from my trading colleagues. However, I am looking to set up a trading arcade of my own and maybe the publicity would be a good thing for the arcade. Maybe we can do something in the future.

  Best regards,

  Navinder.

  Nav never did feature in Trader Monthly, and he didn’t start his own arcade, but he was beginning to outstay his welcome at Futex. Once a major generator and a great advertisement for the firm, he was increasingly looking like a liability. He came to the office less and less frequently, and when he did turn up, he caused trouble. At one point, he complained that his bank was stealing money from his trading account. When the Rossis told him he was mistaken, he questioned whether they were in on it. Nav’s nosebleed stakes were giving management sleepless nights and, if he took home any more than 90 per cent of his profits, the economics no longer stacked up. Earlier in the year Nav had paid to ‘lease a seat’ at the CME – essentially, a form of membership with privileges – which slashed the fees he paid the exchange per trade, in turn eating into Futex’s commissions. The firm also suggested it had received warnings from Her Majesty’s Revenue & Customs that Nav wasn’t paying his taxes.

  Matters came to a head in the summer of 2008 when Nav told Futex he was leaving and wanted his capital, a sum of around $3 million. At first Paolo resisted, telling Nav he’d return the money in installments until he was confident the tax authorities were happy. When Nav instructed a lawyer to begin legal proceedings, Paolo caved, but ties between the two men were severed for good.

  ‘At the best point our relationship would have been mentorstudent, at the worst point you’re dealing with a mentality that if you hold him back, he feels like you’re against him,’ says Rossi. ‘If you don’t give him the limits he wants, you’re against him, if you’re taking a clearing fee, you’re against him. He’s got this mentality that everyone is ripping him off. But we nurtured him and at Futex he knew everyone. It was like a brake on his worst instincts. When he left there was no one to look out for him.’

  CHAPTER 7

  THE TRADE II

  Nav’s first task on leaving Futex was to find a new broker. Every independent trader is required to trade via a regulated brokerage firm, which acts as a kind of conduit to the exchanges, covering any losses and monitoring their clients’ activity. In April 2008, Nav called GNI Touch, an offshoot of Man Financial Group (later renamed MF Global), the world’s biggest futures brokerage firm. At the time, he was still locked in the dispute with Futex and had only around $750,000 to put down as margin. The fee that brokers charge their customers per round-trip ranges from a few cents to a couple of dollars, depending on the volume they trade. ‘Whenever we take on someone new, ninety-nine per cent of the time they’ll inflate what size they do and how much profit they make, and not just by a little bit,’ says a former senior member of GNI’s futures desk. ‘They’ll say “I do a hundred thousand lots a month,” and it’s actually more like five thousand.’

  When Nav said he did ten thousand round-trips a day and regularly made $110,000, the GNI executive chuckled to himself and offered him rates commensurate with a trader who does one-fifth that amount. A few days later, he found out Nav was telling the truth when an engineer drove to Hounslow to set up the software and a connection to the exchange in Nav’s bedroom, allowing his brokers to watch him remotely. Astounded, GNI slashed Nav’s fees accordingly. Once a trader is up and running, there’s not actually much for a broker to do. A big part of the job is maintaining relationships, and it’s not unusual for a company like Man to throw back 20 per cent of whatever it collects from a customer in fees on lavish meals, nights out, or tickets to events. Man had a box at Wembley Stadium and another at the O2 Academy concert hall. But Nav wasn’t interested. ‘He never wanted any entertainment and kept contact to the absolute minimum,’ says the ex-GNI broker. ‘His ambitions were clear: he wanted to be the largest trader in the market and was totally uninterested in material gain. The profits just allowed him to trade bigger.’

  Nav started trading from home just as the financial crisis was peaking. With so much volatility, there was still easy money to be made, even with the proliferation of the algos. Markets lurched around with every fresh piece of bad news or government attempt to restore calm, and many of the moves were predictable and overblown. In such frenetic markets, it was easy to miss things and Nav thought he might benefit from being surrounded by other people, so he rented a desk for $2,300 a month at an outfit called CFT Financials, where, unlike at Futex, he didn’t have to give up any of his profits. Located a short walk from the Tower of London in the old financial district, CFT was founded by a high-rolling day trader known as ‘Braveheart’ who graced the inaugural cover of Trader Monthly leaning on the hood of a vintage car with a model in his arms. The thirty or so traders at the firm were generally older and more experienced than those at Futex. No one was screaming obscenities or playing football in the car park. Still, when Nav arrived, the atmosphere was abuzz. Bid-ask spreads had burst wide open, reflecting the heightened level of risk, and there were opportunities to make weekly salaries in a day. To capitalise, Nav worked from morning until night, trading European markets first and then switching to the e-mini. After a few weeks, he made his second career-defining trade and, like the last one, it had less to do with scalping than with sheer conviction and intuition.

  On Thursday 20 November 2008, the S&P 500 closed at 752 points, its lowest level in more than a decade. Two months had passed since the collapse of Lehman Brothers and, with the financial system still teetering, reports suggested the US government and the Federal Reserve might have to adopt more drastic measures. Arriving in the office on Friday morning, Nav started loading up on S&P 500 futures, reasoning that markets had only one way to go. Sure enough, after a shaky few hours, US stock prices started to climb. The following week, they rallied even harder when the Treasury Department announced it would inject $40 billion into Citigroup. Believing the market had further to go, Nav added to his long position until every dollar in his account was on the line.

  Watching on from GNI’s offices, Nav’s brokers were growing nervous. Not only was Sarao sailing close to the trading limits they’d set him based on the margin he’d put down, but he hadn’t placed a stop-loss to limit his potential downside. If the market suddenly tanked, the firm could take a serious hit. Eventually, the senior broker on the desk came to the conclusion he had no choice but to call Nav and ask him to top up his account. When Daljit, Nav’s mother, answered, the broker asked her to wake him up. Nav came to the phone sounding irritable. Before the broker could finish explaining why he was calling, Nav growled, ‘What are you talking about, bruv? Look at the market!’ The broker had failed to notice that the S&P 500 had been on another tear. Before he had a chance to apologise, Nav told him he was going back to bed.

  Later that day, the Federal Reserve announced it was allocating $800 billion to ease the flow of credit around the system. It was the bazooka the markets had been waiting for, and by the time the market closed in New York, the S&P 500 stood at 857 points, marking a rally of 100 points in three days. It was a staggering rise of a magnitude that comes along only every few years. At that point, Nav could have cashed out for a hefty profit, but once again he doubled down, putting his winnings back on the line. Rather than waiting and watching, he took himself out of the office to a nearby McDonald’s, where he drank four milkshakes in a row. It was the ultimate manifestation of his ‘let it breathe’ philosophy. By the time he exited his position two days later, the index had risen a further 39 points. Over the course of a week, the S&P 500 had gained more than 19 per cent, and Nav had ridden the tidal wave to the shore, earning himself around $15 million.

  ‘People think it’s gambling, but it’s almost the opposite of gambling,’ reflects one day trader. ‘The package gets voted in and it’s like having two aces in poker, but you have to have massive balls. Shall I go all-in or not? The market has only one way to
go. But you have to be willing to put everything on the line.’

  A few days later, the senior broker called Nav to congratulate him on his win and ask what he planned to do with the money. When Nav replied, ‘Trade it,’ the broker warned him about the danger of viewing profits as an abstract number, a lesson he’d learned to his detriment in the pits. The broker advised Nav to buy himself something nice, but Nav said he didn’t need anything and steered the conversation back to his favourite subject: the menace of high-frequency trading. Since joining CFT, Nav had become more convinced than ever that the HFT firms could see who was behind orders, and he complained about it to his brokers ad nauseam. He had also come to believe the robots were able to see where stop-losses were sitting – potentially valuable information that would allow them to trigger flurries of buying and selling. Even now, on the back of a life-changing win, Nav was preoccupied with how he was being cheated. Sensing he was wasting his time, the broker wished him well and hung up.

  Around this time, Nav did treat himself to one indulgence: a Volkswagen Golf. The traders at CFT smiled as he talked enthusiastically about overtaking other cars in what was essentially a run-of-the-mill hatchback, after earning more in a week than the annual salary of Goldman Sachs’s CEO. His interest in the vehicle waned when he picked up a couple of parking tickets, and within a few months it was rusting on a driveway, where it would remain, untouched, for years. Eventually it was towed away for scrap. After factoring in depreciation and running costs, Nav told anyone who would listen, owning a car was a bad trade.