Here is a great overview of "high frequency trading."
Read more here:
High frequency traders employ pattern recognition algorithms that look deeply at bids and offers on stocks to determine if the movement on the bid quotes or offered quotes implies a directional tendency.
Computer-driven algorithms are “reading” the quotes, the intentions of buyers and sellers as they put down their orders in real-time, to make a trade that the HFT player expects to profit from if the directional bias their computers pick up is correct.
HFT computers look at all the bids and offers wherever any stock is traded. Sometimes stocks are traded at several different exchanges or “venues” at the same time.
But trading the price discrepancies that sometimes occur because there are different quotes at the same time at different exchanges for the same stocks isn’t where HFT players make their money, although they do that, too.
What the HFT boys actually do more of than high frequency trading is “high frequency quoting.”
They have their computers send out their own bids and offers, or quotes, to all the exchanges, almost all the time.
How HFT Manipulates Markets
What they are doing is trying to influence, I call it manipulate, what other traders and investors do with their bids and offers. They are trying to fake or set-up other market participants to react to the quotes the HFT players fire out onto the exchanges for all the stocks they trade.
Only the HFT quotes sent out aren’t meant to be acted on. They aren’t looking to buy on their bid quotes or sell on their offer quotes.
Instead, they are sending out orders to “ping” markets.
Ping refers to how sonar works. For example, a submarine sends out a sonar beep which hits a target and sends back a sound (which sounds like a ping) which the sonar operator “reads” to determine the pinged object’s distance and shape.
HFT players are constantly pinging stocks where their quotes are housed and displayed. They send out their orders to manipulate others to adjust their quotes, which get fed into the HFT algorithms to determine any directionality; then, if an opportunity exists the HFT computers buy or sell shares that someone else has put onto the market.
They aren’t quoting constantly as bona fide “market-makers” are supposed to do, which they claim they are acting like. They are simply putting out millions of fake bids and offers which they pull almost immediately, just to read the movement of other market participants who react to the HFT come-ons.
It isn’t illegal. But it is manipulation.
Read more here:
http://etfdailynews.com/2012/10/16/the-truth-about-high-frequency-trading-and-the-coming-stock-market-crash/
Part 2 of article (no increase in liquidity, but increased chances of out-of-control markets)
http://etfdailynews.com/2012/10/19/unless-we-act-high-frequency-trading-will-crash-the-stock-markets-indexsp-inx/Part 2 of article (no increase in liquidity, but increased chances of out-of-control markets)
