To generate $40 million in gains over a period of four years, including nearly $1 million in the May 2010 U.S. stocks "flash crash," Navinder Singh Sarao used a couple of fairly simple techniques that let him push futures prices down, buy the contracts on the cheap, and then profit from the sale.
Sarao never intended to make good on the orders, a criminal complaint unsealed on Tuesday said; the point was to create the false impression of a large supply of contracts just waiting to be sold should the price rise just a bit, an impression that exerted a steady downward pressure on prices.
Dubbed dynamic layering, one technique relied on a customized computer-trading program to place large sell orders for contracts tied to the Standard & Poor's 500 Index. Sarao began using it in 2009, according to the complaint.
The orders were modified and canceled with split-second precision so that they tracked the actual price of the contracts, but at prices just enough above the going price that Sarao could be confident they would not become actual trades.
Because the orders were big, they helped create the fiction that the market had more depth, or layers of prices, than it actually had.
A second, related technique Sarao used was to simply place large sell orders, each for either 188 contracts or 289 contracts, all of which he canceled before they could be executed.
The large orders created a big imbalance in CME Group's exchange order book, again putting downward pressure on prices by creating the appearance of excess supply.
As the complaint said, Sarao "appears to have used this 188-and-289-lot spoofing technique in certain instances to intensify the manipulative effects of his dynamic layering technique," the complaint said.
"The purpose of these bogus orders is to trick other market participants and manipulate the product's market price."
One of those instances was on May 6, 2010, when the Dow industrials fell about 1,000 points.
Sarao started his dynamic layering at about 9:20 a.m., ramping it up intensively from 11:17 a.m. until 1:40 p.m., the complaint said.
Starting at about 12:33 pm, Sarao added his spoofing technique, placing large sell orders that added to the downward pressure on the contracts.
As the price of the contracts fell, Sarao selectively bought the artificially cheap contracts, selling them at a profit, the complaint alleged.
By the end of the day, he had amassed a profit of $879,018.