Flash Crash

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 tell 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?

The closest thing to a bible for traders is Reminiscences of a Stock Operator by Edwin Lefèvre. Published in 1923, it recounts the early life and wisdom of Jesse Livermore, a trading guru who went from watching prices on a bucket shop ticker tape at fourteen to making and losing a fortune many times over. At Futex, wet-behind-the-ears graduates and grizzled veterans alike mined well-thumbed copies for insights. It was said that Livermore, who was given the nickname the ‘Boy Plunger’ for his habit of profiting from financial crashes, could ‘read the tape’ – that is, he could look at price movements in a security or future and accurately predict where it was heading based on his careful study of past behaviour. The reason for the move was almost incidental, he maintained. What mattered was that it would move and which way. ‘There is nothing new in Wall Street,’ wrote Lefèvre, channelling Livermore in a famous passage. ‘There can’t be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again. I’ve never forgotten that. I suppose I really manage to remember when and how it happened. The fact that I remember that way is my way of capitalising experience.’

Sarao may not have reached the same heights as Livermore, and his lifestyle was certainly more abstemious than the freewheeling, three-times-married American playboy, but, years later, his peers at Futex would point out some striking parallels. Both started out with nothing on the fringes of finance and had photographic memories; both could divorce emotion from their decisions and were willing to risk ruin for a shot at glory; both prided themselves on the conviction of their calls and hated discussing trading with anyone else lest their instincts be contaminated. They would both also end up inextricably linked to market crashes. Livermore, who earned $100 million shorting stocks in 1929 – the equivalent of more than $1 billion today – ended up squandering it all and shooting himself in the head in the cloakroom of the Sherry Netherland Hotel in Manhattan in 1940. For those paying attention, Livermore’s life is a cautionary tale about the dangers of blind obsession and the perils of tying your destiny too tightly to the whims of the market. The traders at Futex only ever talked about his legendary skills.

CHAPTER 3

THAT’S A FUGAZI

A few weeks before Nav joined Futex, a post titled ‘Elliot and Gann analysis exposed’ appeared on a popular day-trading forum. Its author was a newcomer to the boards who called himself ‘That’s a Fugazi’ and used a picture of the Joker as his avatar.[fn1] On the brief bio attached to his profile, he described his trading style as ‘WINNING – period. Losses do occur, but only as often as the soccer World Cup.’ Under ‘list of markets traded’, he wrote: ‘I’d trade fruit and veg as long as it made wonga.’ The signature that ran along the bottom of his posts read: ‘OH SHEEP COME JOIN THY SHEPHERD IN THE LAND OF THE RICH AND BEAUTIFUL!’

When Nav created his online alter ego, he was a newcomer to trading, twenty-four years old and still buying and selling individual stocks rather than the index futures that would make him rich. His idiosyncratic way of seeing the world and preternatural confidence, though, were evident from the start. Indeed, his opening gambit on the site was a repudiation of two of the godfathers of trading theory. Ralph Nelson Elliott was a Kansas-born accountant who, in 1938, published a book called The Wave Principle that posited that markets move in discernible and therefore predictable wave formations based on the ebb and flow of crowd sentiment from optimism to pessimism. According to Elliott, while markets might appear to be random, they are in fact governed by recurring patterns grounded, like much in nature, on the Fibonacci sequence. Sarao was unconvinced: ‘I am well versed in Elliott waves – indeed I have the E-wave bible and have made some astounding predictions based on it. Yet I soon realised, after throwing away my rose-tinted glasses, that 70% of the time a chart can fit numerable e-wave patterns of [sic] no pattern at all. Which means one is up the proverbial creek if one is limited to that technique.’

Writing around the same time as Elliott was William Gann, a Bible-toting son of a Texas cotton farmer who sought to apply principles gleaned from geometry, astronomy and astrology to forecast cycles in commodities markets. Nav gave Gann even shorter shrift: ‘Well let me tell you all that literally a 12-year-old kid could use this method, it’s a simple method of algebra, an intellectual mind like mine does not even require a calculator for this one … I challenge anyone here to name a way Gann has helped them make money.’

Nav wasn’t the first person to question the principles of technical analysis, a school of trading that uses charts and statistics rather than economic fundamentals to try to predict the direction of prices. Elliott and Gann had both been dead for half a century, and their respective methods had been so widely pulled apart they had reached the status of sacred cows in some quarters. But his blunt assuredness was striking for someone who had barely formally studied finance and whose trading experience was confined to buying and selling a few stocks. It was akin to an economics freshman discounting the work of John Maynard Keynes or an unpublished writer ripping into Charles Dickens. One of Nav’s objections, beyond his contention that Elliott’s and Gann’s methods didn’t work, was the idea that the universe and everyone in it were governed by some overarching natural law. ‘Which means that in essence EVERYTHING HAS BEEN WRITTEN BEFOREHAND,’ he wrote. ‘You need to believe EVERYTHING [sic] LITTLE THING IS DESTINED. That we are mere robots without any free will or choice.’ Nav prided himself on being a freethinker who formulated his own views about the world based on the abiding principle ‘Do Your Own Research’, or DYOR. ‘I wish I could tell you, (the sheep) the way to unlock yourselves from following the herd,’ he wrote in a follow-up post. ‘[M]ost of you are doing it without even knowing it, we are all programmed form [sic] birth to follow society in fashion, values etc etc and must atune our minds to think independently.’

That’s a Fugazi’s critique proved predictably contentious. Some of the forum’s members jumped to Elliott and Gann’s defence. Others mocked Sarao’s unpolished delivery. ‘Please accept my sympathy by the way, as it sounds like your bedsit floor must have collapsed,’ wrote one. ‘I’ll have a pint of whatever Mr Fugazi is drinking,’ wrote another. Nav failed to see the funny side and accused them of lacking the intellect to understand what he was saying. ‘SHEEP ARE HOSTILE WHEN ENCOUNTERING BRILLIANCE,’ he wrote. The exchange set the tone for Nav’s activity on the forum over the next few months. Under the guise of talking about trading he would abuse his fellow posters and make outlandish claims about his own talents. He posted a poll titled ‘Can Fugazi tell the future??’ with options that included ‘Maybe, but it’s kinda scary to face up to what he predicts’ and ‘No more need for crystal balls, he knows it all’. He also claimed to run a seminar on ‘trading and LIFE’, but when pressed about how to sign up, he declined to provide any details.

At first, the other forum members found That’s a Fugazi’s posts, with titles like ‘Proof of pure unadulterated genius’, amusing. They were full of references to ‘mugs’, ‘moola’ and ‘tings’, which earned him the nickname ‘The Sage of Peckham’, a working-class neighbourhood in London. One poster asked if he was Ali G. But by the summer the entries had started to take on a darker hue. With the Iraq War raging and 9/11 fresh in the memory, Nav claimed he could foresee terrorist attacks thanks to his unparalleled ability to read financial markets, ‘the most powerful predictive tool in the world’. When fellow posters complained he was being insensitive, he wrote: ‘Unlike the majority, I prefer to face the truth no matter how horrible it is, and until civil war breaks out in the UK and elsewhere as it will in the next 15yrs, the future will be a scary and horrible one.’

By now Nav had been at Futex for a few months, and a clear chasm existed between his larger-than-life online persona and the enigmatic young man who made his way to Weybridge each day to learn to trade futures in the real world. At work, Sarao was hardworking and quiet; not exactly lacking in confidence but somewhat awkward and preoccupied. Then, each evening, when his fellow recruits headed off to the pub, he returned to Hounslow and unchained the increasingly megalomaniacal Fugazi once more. ‘Hello all, I know you missed me but you won’t admit it,’ he wrote one day that summer, before assessing the statistical likelihood of a biological or nuclear terrorist attack (80 per cent) and the assassination of George W. Bush (20 per cent).

‘I am going to be accused by many a sheep of being part of Al-Qaeda,’ he went on. ‘This is the typical retort when one is stuck of ideas. First let me expalin [sic] to you that I am not Muslim, so that kinda rules me out I guess. It’s funny, the hypocrisy that lives in this world. I mean I’ll get dirty looks in the street for being brown skinned, yet there have been more white caucasian people convicted of Al-Qaeda attacks than of my community.’

Eventually, That’s a Fugazi overstepped the mark. The forum’s administrators warned him about trolling and his fellow posters turned against him, blocking him from their feeds. ‘Anyone who seeks to gain by boasting of “predicting” terrorist attacks is beneath contempt,’ wrote one. Nav denied he was seeking to gain anything and suggested his critics had been ‘brainwashed by mass media’. Later that day he wrote: ‘apologies for the harsh tone. BUT THE SOLE REASON THIS WORLD IS IN THE STATE IT IS, IS BECAUSE NONE OF YOU CAN BE BOTHERED TO FIND OUT ABOUT THE WORLD YOU LIVE IN.’ For a couple of months, Fugazi disappeared from the boards before returning with a new thread about how he’d switched from trading individual stocks to index futures like the e-mini. ‘As you can guess I’m doing rather well,’ he wrote. But where the early posts had garnered dozens of responses, this time nobody bothered to reply. Amid the silence he pleaded: ‘Come back to your master oh herd, thou art nothing without Him.’

CHAPTER 4

THE TRADE I

After years of patiently building up his account, Nav pulled off a trade at the start of 2008 that would catapult him into the big time and go down in history at Futex. The global financial crisis, which had started to make its presence felt the previous spring, was gathering pace. Markets lurched around on news of the precarious state of the economy and the measures governments and central banks were taking to shore up the system. Where the S&P 500 might previously have moved forty or fifty ticks in a day, it was now not uncommon for the index to jump around in a range of 5 per cent, more than five times as much. The turmoil may have been disastrous for the wider economy, but it was a boon for traders like Nav who thrived on the action. Sentiment had swung firmly from exuberance to panic, and there was easy money to be made. Every time a bank reported big losses or a hedge fund announced it was folding, the market reliably tanked. Quick-fingered scalpers had only to wait for news to come out of the squawk box, ride the downturn and get out a few moments later before the rest of the world caught up. Order books were full of forced sellers who had no choice but to offload assets to raise cash or hedge their mutating portfolios. There was always a heightened risk of disaster in such volatile markets, but life was generally sweet for Paolo’s squadron of day traders.

Late one afternoon in early January, Nav was at his desk at the Cornerstone when he noticed something odd in the DAX, an index that tracks Germany’s thirty biggest companies. Despite the swirling negativity, there was a glut of buy orders waiting in the order book; and whenever the bids were hit, Nav observed, they quickly replenished. The result was that, over the course of the evening, while most US and European markets remained depressed, the German index actually crept higher. Somebody out there appeared to have an insatiable appetite for DAX futures in the face of strong signals that prices should be going down. Nav stood up and went to speak to Brad Young.

‘It’s the Chinese, I fucking know it,’ Young barked when Nav asked him what he made of the mysterious buying. Residing as they did on the fringes of the financial firmament, traders at Futex were inclined to indulge in conspiracy theories about sinister forces controlling the markets. If it wasn’t the Chinese, it was the Plunge Protection Team or Goldman Sachs or the Bilderberg Group. Young’s theory this particular evening was that the People’s Republic of China had become so rattled by the turbulence in the US financial system it had decided to shift some of its vast resources into Europe. It wasn’t completely outlandish. China regularly intervened in the foreign exchange markets to stabilise its own currency. Plus, whoever was buying up the DAX had significant firepower. For long periods there were hundreds of millions of dollars’ worth of bids sitting in the order book.

Nav rarely discussed his trading strategies with other people. Partly that was due to fear that he would be pushed off his game, but he had also developed a finely honed bullshit detector. He’d long since decided that the trainers who came and went at Futex were full of crap. If they really knew what they were talking about, why were they wasting their time on a bunch of noobs? Even Paolo, legend of Liffe and the firm’s founder, received a roll of the eyes when he tried to offer Nav any words of wisdom. But to Nav, Young was different. He didn’t just talk a good game. He backed it up, risking tens of thousands of dollars when he felt good about a trade. And unlike Nav, he was a DAX specialist.

Young grew up catching waves in a surf spot one hundred miles north of Sydney. After spinning up a bankroll buying and selling equities in between classes, he had moved to London to do some travelling and try his hand at trading futures. Outwardly laid-back, he had a fiercely competitive edge and a burning obsession with the markets that rivalled Nav’s. Back at Weybridge, their relationship had got off to a rocky start. Fed up with the state of the kitchen one day, Young had spent hours cleaning up, only for Nav to put a fish pie in the microwave without a lid. When the pie exploded, spraying the kitchen in gunk and leaving the cramped office stinking of fish, Young lost his temper and started shouting at Nav, who hurled obscenities back. After a tense few seconds, they both cracked up laughing. Since then a friendly rivalry had built up between Futex’s two stars. Still, while Nav had some cachet around the floor, Young was the one the rookie traders really wanted to be like, showing up to work dressed like he was going to the beach and going on exotic holidays every few months. If the team went to the pub early on a Friday, Young left his credit card behind the bar, asking only that they return the favour one day when they had some success of their own. Once, after a particularly profitable week, he ferried them all to a swanky bar in Kensington for a night out. Young was the living embodiment of why many of them got into day trading in the first place: a charismatic, happy-go-lucky master of his own destiny who made a shedload of money without answering to the man.