How a mystery trader with an algorithm caused $1 trillion US stock market crash from his bedroom

One fateful day in 2010, the US stock market lost a whopping $1 trillion briefly in a bizarre incident called the "Flash Crash". However, it was only temporary as the market recovered in minutes, leaving traders scratching their heads. Years later, the FBI traced the source of the crash to a then 37-year-old man, living in the UK.

Navinder Singh Sarao, who was nicknamed the 'Hound of Hounslow', was accused of 'spoofing' the market. The mastermind who made millions in profits was eventually charged with crimes that could put him behind bars forever, as per the BBC . The young man caused a trillion-dollar market crash from the comfort of his bedroom.

Who is Navinder Sarao?

Before he became infamous, Sarao was a little-known trader from the U.K. He lived and operated from his parents' house in the  London borough of Hounslow. As per The Sun , Sarao graduated from London's Brunel University with a degree in computer science. He then joined as a trainee at the trading firm Futex, where he gained a reputation as a huge risk-taker. He sometimes raked in up to  £500,000 (~$6,56,292) in a day.

However, he chose not to spend his fortune and even kept his earnings from his parents, the Telegraph reported. Being a frugal man, Sarao soon got fed up with sharing his profits with Futex, so he moved to CFT Financials, which rented space to private traders. It was during this time that he came across techniques that allowed him to manipulate markets and make huge profits.

How did Sarao cause the "Flash Crash"?

Sarao was operating in the Chicago Mercantile Exchange, which is known to be a highly computerized market. In the exchange, computers and algorithms operated high-frequency trading programs that took advantage of ups and downs in the market within milliseconds, before any human could even click a mouse button.

During his trades, Sarao realized that since the computers ran the same algorithm that anticipated market movement based on buy and sell orders, they largely moved like a pack of sheep. He also got the idea that this pack could be easily spooked or 'spoofed' as well.

According to the FBI investigators, Sarao modified a commercially available piece of software which was a trading algorithm, to spoof the nearly fully automated market. Operating the software at high speed, Sarao allegedly placed big sell orders, often worth hundreds of millions of dollars in a day trade, to manipulate the market.

As the other computerized traders picked up on the information, they would calculate that Sarao's sell orders would outweigh the buy orders and cause the market to move down. This triggered them to sell assets before the orders went through to prevent a loss. Ultimately, since they moved like a flock, the massive selling would cause the market to move down.

Taking advantage of this, Sarao would cancel his sell orders and pick up assets at a lower price instead. Once the market realized that the sell orders had gone away, it would bounce back to normal, earning Sarao a handsome profit.  Thus, when a similar incident occurred in the U.S. stock market on May 6, 2010, where the Dow Jones index lost 700 points, erasing $800 billion in value of US shares, before recovering quickly, the FBI claimed that it was partly caused by Sarao and his tricks.

The hound eventually howled

The "Hound of Hounslow" title was given to Sarao as a reference to the "The Wolf of Wall Street" film that made Jordan Belfort's story famous. However, Sarao was in many ways different from Belfort as despite making £10 million (~$13.1 million), he didn't spend his fortune or live in luxury, BBC reported.

Sarao was eventually arrested and extradited to the US where he faced 22 charges carrying a maximum sentence of 380 years. However, Sarao's lawyers claimed that it wasn't their client's actions that caused the 'flash crash' and it was a U.S. hedge fund that was responsible.

In 2016, he pleaded guilty to only 'spoofing' which is fraud and illegally manipulating the market, in U.S. law and faced up to eight years in prison. He also agreed to pay the U.S. government $12.8 million. According to Bloomberg , the prosecutors did not push for a prison sentence. In 2020, a judge sentenced him to one year of supervised release taking his autism and prison time that he already served into consideration.