[balbeit]

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?

[aleyan]

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.

[dchichkov]

In reality spread would be $0.01 or 0.02 and these two investors would meet in the middle. Even on different exchanges. Thanks to HFT guys.

[aleyan]

Yes, I edited that little bit in for clarity.

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.

[krickle]

If HFT firms buy at 1.60 and sell at 1.59, where is their money coming from?