A Layering Algorithm was behind the 2010 « Flash Crash » that sent the Dow Jones Industrial Average (DJIA) on an unexpected and irrational 1000-point ride, putting an indefinite number of traders out of business. A flash crash is a very quick and volatile fall in security price that takes place in an extremely short time period. Back in May 2010, a day trader named Navinder Singh Sarao allegedly sent the DJIA down more than 600 points in just several minutes. According to the US Commodity Futures Trading Commission (CFTC), UK resident Sarao manipulated the stock market using E-mini S&P 500 futures contracts which are smaller version of typical futures contracts that allow one trader to buy or sell the value of the S&P 500 index at a future date.
According to the CFTC complaint, between April 2010 and April 2015, defendants including Sarao utilized a Layering Algorithm on over 400 trading days and profited over $40 million in total from creating temporary artificial volatility. The CFTC determined their how-to and wrote that they automatically simultaneously “layered” four to six exceptionally large sell orders into the visible E-mini S&P central limit order book with each sell order one price level from the other. As the futures price moved, the CFTC added, the algorithm allegedly modified the price of the sell orders to ensure that they remained at least three or four price levels from the best asking price; thus, remaining visible to other traders, but staying safely away from the best asking price.
On May 6, 2010, the day the flash crash took place, they utilized their algorithm continuously, for over two hours, immediately prior to the precipitous drop in the E-mini S&P price, applying close to $200 million worth of persistent downward pressure on the E-mini S&P price, the CTFC explained. Such manipulative activities did contribute to “market conditions that led to the flash crash” an official news release stressed. Sarao now risks extradition to the USA on charges of manipulation, attempted manipulation, spoofing, and wire fraud. For others however, the suspected actions of Sarao and his co-defendants couldn’t explain all by themselves the flash crash’s magnitude.