How bedroom trader Navinder Sarao made his first millions and kickstarted an odyssey that ended with historic market manipulation and a $1 trillion crash
Navinder Singh Sarao made $70 million buying and selling futures from his suburban London bedroom before the FBI showed up to arrest him for helping cause a $1 trillion market crash.
A preternaturally gifted trader with a penchant for computer games, Sarao was accused by the US government of manipulating markets by posting then canceling huge volumes of orders to trick other participants about supply and demand - a brand new offence known as 'spoofing.' He believed his actions were justified because the markets were rigged in favor of highly-profitable, computerized entities known as high-frequency traders, or HFT. Many agreed, and in the aftermath of his arrest, Sarao became a kind of folk hero to those on the fringes of the financial ecosystem -the lone trader who took on the billion-dollar behemoths and won.
Sarao started his trading career at a rough-and-ready prop shop above a supermarket. In an extract from his forthcoming book, Flash Crash, Liam Vaughan recounts how the man dubbed the Hound of Hounslow made his first million pounds after crossing paths with another notorious financial figure.
After a few 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. The global financial crisis was gathering pace and 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 percent, 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. sh_cad_6
Late one afternoon in early January, Nav was at his desk 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, 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.
"It's the Chinese, I know it," suggested one trader 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, the arcade where Nav cut his teeth, were inclined to indulge in conspiracy theories about sinister forces controlling the markets. If it wasn't China, it was the Plunge Protection Team or Goldman Sachs or the Bilderberg Group. 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 resigned to keep watching the DAX and went home for the night. The following morning he saw that the index had opened 90 points lower, a substantial drop. Whoever was propping up the market had seemingly given up and gone to bed. Over the next few hours, DAX futures continued to tumble in line with markets around the world, but by late afternoon the wall of bids had reappeared and prices started to edge up again.
It was surreal. During the regular trading day for stocks, from 9:00 a.m. to 5:30 p.m. Central European Time, German futures followed the global downward trend. Then, when the country's stock market closed and volumes thinned out, DAX futures, which keep trading until 10 p.m., began edging higher, like a salmon swimming against the stream. It wasn't clear who was behind the phenomenon or why. In some ways it didn't really matter. The important thing was that there was a trend that could potentially be exploited.
That night, before heading home, Nav and one of his colleagues devised an experiment. Both of them would sell a few DAX contracts and see what happened. If the market took a tumble, as it had the previous night, they would buy back the same number of contracts the next morning, closing out their position for a profit. If it didn't, they would take the hit and move on with their lives. Generally speaking, it was frowned upon at Futex to leave a position open overnight because you couldn't react quickly if the market moved against you. They needn't have worried. The following morning the DAX opened 65 points lower, earning them more than $10,000 apiece. By day three, the traders around them had started to take notice. There still hadn't been anything in the press that might explain the move, but the pattern was clear. Half the office followed their suit, hoping to piggyback on the nightly deviation between the German index and markets around the world. Once again, the market rallied before collapsing overnight, this time by 80 points.
Nav had struck gold. For two weeks, he repeated the overnight trade, placing steadily larger positions before heading home to bed and praying his good fortune would hold. Time and again it did, and by the second week of January, Nav had gone from shorting a handful of contracts to betting two hundred lots a night, a $15 million position that yielded six-figure profits. As he put everything on the line, the strength of his conviction never faltered, and by the middle of January his balance had ballooned to more than a million pounds.
ON SATURDAY, January 19, 2008, a thirty-one-year-old French trader named Jérôme Kerviel stood outside Société Générale's imposing headquarters on the outskirts of Paris and texted his boss: "I don't know if I'm going to come back or throw myself under a train." Waiting for him in a conference room inside were the head of the bank's investment banking division and various other executives who had spent the past twenty-four hours frantically scouring Kerviel's trading records after uncovering evidence of what they suspected to be a massive fraud. Over the next several hours, Kerviel confirmed their fears. Starting in 2005, he confessed, he'd been secretly placing unauthorized trades worth hundreds of billions of dollars. Unlike most of the firm's elite traders, Kerviel, the son of a blacksmith and a hairdresser from Breton, had started his career in an administrative function, and it was there that he'd learned how to cover his tracks using a combination of fictitious transactions and forgery. He'd escaped detection because, for the most part, he'd been successful. In 2007 alone, he said, he'd made a profit of around $2 billion by correctly predicting the impact of the impending financial crisis. Bizarrely, he was never able to claim credit for his success, because nobody else knew about it. The story might have ended there, except Kerviel had recently embarked on his most ambitious foray yet. sh_cad_12
Between January 2 and January 18, the trader had accumulated a long position of $70 billion, double the market capitalization of the entire bank. As his colleagues left the trading floor each evening, Kerviel had stayed behind manically buying futures tied to the DAX and other indices, convinced that the worst of the crisis was over and that the markets would rebound. But his winning streak had come to an end. Kerviel's wave of after-hours buying only ever propped DAX futures up for a few hours each night. Then, like some horrific Wall Street version of Groundhog Day, he awoke each morning to find gravity had kicked in and the market had sunk back in line with the rest of the world. As Kerviel made his confession, Société Générale's management ordered one of his colleagues to close out his positions. By the time the employee was finished, the bank had lost $7.2 billion. News of the incident rocked global markets and helped push the DAX 12 percent lower in two days, wiping hundreds of billions of dollars off the value of Germany's biggest companies.
Reading about events at Société Générale, the traders at Futex quickly worked out that Kerviel had been the one behind the DAX's strange maneuverings. It wasn't the Chinese after all. One of Europe's biggest banks had been brought to the brink by a lone trader with oversize ambitions and inadequate oversight. Later, Kerviel was sentenced to three years in jail and ordered to pay back the entire $7.2 billion he lost, the biggest fine ever levied on an individual. His desperate buying spree placed him among history's most notorious rogue traders, a name uttered alongside the likes of Nick Leeson of Barings Bank and Kweku Adoboli at UBS. It also gave a young day trader from Hounslow the capital he needed to take his trading to new heights.
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