NEW YORK: He operated from a modest suburban London home he shared with his parents, far from the city’s glamorous financial centre. He used off-the-shelf software anyone can buy.

Yet, if US authorities are correct, Navinder Singh Sarao, 36, managed to send a jolt of fear through the world’s markets by helping to set off the 2010 “flash crash,” in which the Dow Jones average plunged 600 points in less than seven minutes.

Just how big a role he played has been hotly debated since the federal complaint was unsealed earlier this week, but the idea that a little-known investor had even a small part is deeply troubling, say traders and market experts.

“If this guy can do it,” asks finance professor James Angel of Georgetown University, “who else is doing it?”

In an age of rapidly advancing computer power, the fear is that it’s not just big banks and hedge funds that can create chaos on exchanges and wipe out the savings of millions of ordinary investors. Someone working from home might be able to do it, too.

“The risks are coming from the small guys who are under the radar,” says Irene Aldridge, managing partner of research firm ABLE Alpha Trading and an expert in the kind of high-speed computerised trading that Sarao did.

“The regulators don’t have the real-time tools to monitor them.”

Sarao allegedly employed a ruse called spoofing, a bluffing technique in which traders try to manipulate the price of stocks or other assets by making fake trades to create the impression they want to sell when they really want to buy, or vice versa.

Eric Scott Hunsader, founder of Nanex, a provider of financial data that has documented what it claims are cases of blatant spoofing, says the practice is widespread — in stocks and bonds, oil and gold, cotton and coffee.

He says the bluffing is turning markets into a lawless Wild West, despite efforts by trading firms to fight back with software that can sniff out the false trades.

If the allegations against him are true, Sarao may rank among the best of this new breed of bluffers.

His feat was impressive because of the target of his alleged bluffing — investors in E-Mini S&P 500 futures, which are financial contracts that allow you to bet on the rise and fall of the Standard and Poor’s 500 stock index.

Passing off a fake trade like that as real, much less moving prices, isn’t easy, because E-Mini is one of the most widely traded, transparent and scrutinised markets in the world.

“Everyone is watching it,” says Manoj Narang, former CEO of Tradeworx, a high-frequency trading firm.

A key to spoofing is placing large orders to sell or buy without ever executing them. Since other traders can see your orders, a large one to sell might convince them prices are likely to head down. One to buy might make them think prices are likely to rise. So they will often mimic your order, which moves prices up or down, as if you had sold or bought yourself.

Next, you cancel your order, and do the opposite — buying at the new, artificially lower price or selling at the new higher one.

The advent of high-frequency trading firms has added a level of sophistication and speed to this bluffing technique.

Using computers to sift through news articles, social media feeds and other data in split seconds, these firms are able to snatch tiny, fleeting profits that mere mortals can’t spot. The firms can also bluff fast, sending a series of sell orders, for instance, then cancelling them as the price moves down and replacing them with new orders — all within thousandths of a second.

The complaint against Sarao says it was just this sort of lightning-fast spoofing, called dynamic layering, that allowed him to make nearly $880,000 on May 6, 2010, the day of the flash crash.

Published in Dawn, April 26th, 2015

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