It's fake liquidity IMO, since HF traders are only willing to take a position inbetween someone selling at one price and someone buying a bit high. The trade was going to go through without them in the middle. They are just skimming some money from the buyer, who would otherwise have a lower price at the cost of delaying a trade for half a second.
As a high-frequency trader, I can tell you right now that you are just completely incorrect. I'm staring at a screen right now where we take both sides on every order, not 'skimming some money' from people. It's obvious you have no idea what you're talking about.
I would apologize for harsh language, but I have low tolerance for people who freely speak lies of matters of which they know nothing.
If you aren't making money from having the majority of your trades inbetween two trades you are necessarily losing money. But HFT is profitable for you, which is a contradiction.
tumult: As a HFT do you guys (in the gender neutral sense) ever worry about rogue algorithms? By that I mean an algorithm that could be used to harm the market or essentially "blind" other algorithms.
Before computers, its not like people just waited until they got a price match to make a trade. Human market makers sat in the middle making money the exact same way computers do. Except they weren't as efficient, fast, or smart, so they had to charge higher spreads to compensate.
Are you a trader that likes paying low spreads? Then you probably like the market better now. Are you a trader that loves getting paid high spreads? Then you are probably writing articles about why HFT should be banned.
Can you explain that situation? As I read it, it goes like this. Someone is willing to buy at $1.50, and someone is willing to sell at $1.60. If an investor comes along that wants to buy right now, he has to buy from the seller at $1.60. But say a HFT quickly throws out a sell order at $1.59, so the investor is now able to buy at $1.59 from the HFT. The investor saved $0.01, and the HFT made a trade he must have wanted. Where is the money being skimmed?
Lets take your example and extended to two investors. One who wants to buy and one who wants to sell. If Bid is at $1.50 and Ask at $1.60 then in an efficient market you can expect the two investors to meet at the middle and make the trade at $1.55. That will not occur. Instead of trading with each other, both investors would trade with liquidity providers who will step in to buy from one investor at $1.51 and sell at $1.59. As a result the investors will get their orders filled at only $.01 better than the expected bid/ask and the HFT guy would make $.08 in pure profit.
In reality this does not occur. What happens is that another HFT guy would step in to offer $.02 to each investor in price improvement and take $.06 in spreads. The next HFT guy tries to shave off a little bit more until the spread narrows to $.01. HFT guys then try to take little bits of that remaining spread with exotic order types, rapidly putting and taking off orders, and other tricks and squeezing more money out becomes increasingly difficult.
Edit: To clarify as per dchichkov comment, because of the competition between HFTs guys, the investors would only see a spread of $.01 or $.02. Thus both would trade around somewhere around $1.55 though not necessarily with each other.
The part about squeezing the very last bit of the performance still stands though. Because of mid peg orders and darkpools there could also be fractional pennies which are almost always collected by HFTs. If you watch the trade tape, you may see trades happening with $.009 and $.001 sub penny amounts. These darkpool are trades where someone offers $.001 in price improvement and takes $.009 from the spread at another venue if they are lucky.
Depending on the market and the instrument traded, it can be very rare for "natural liquidity" to generate trades (e.g. mutual fund trades with individual investor through their brokers) and most traded orders interact with some sort of liquidity provider. In these cases, the HFT firms tend to step in front of market makers who are less technically savvy and take the money from them. In this case, customers tend to get better prices on their orders.
One of the big misconceptions about "flash" orders was that customers were being disadvantaged; many customers actually wanted this feature so that they could continue sending volume to more technologically advanced markets such as BATS and Direct Edge and avoid being forced to send to e.g. NYSE (which was very slow) by "trade through" regulations. I've been in the position of wanting this service, and I suspect that most of the criticism came from older markets that were unwilling to invest in technology and change their rules to facilitate faster customer trading.
