[hft_throwaway]

I don't believe they were trading with themselves. They were accumulating stock in the opposite direction to hedge their imbalance-only order. However, the way they accumulated that stock was done in a way that would impact the price received on the closing order.

So imagine they sold 10000 shares imbalance-only in the auction at 3:50. They would then buy 2500 immediately, slowly pick up another 2500 in the next 9 minutes, then do the last 2500 in the last second. The initial trades would get them into their hedge at a low average price, and the last-second ones would push the price of the closing auction up, maximizing their return on their imbalance-only order.

If you read the case, it seems like this didn't always work if they had slippage on the close or they got so aggressive that they would "flip" the imbalance and not get filled on their closing order at all, instead being stuck with a bunch of shares from crappy prices. The people trading with them in the last two seconds could also keep replenishing their orders and prevent them from spiking the price. Sounds like a dangerous game of high-stakes chicken.

[tptacek]

You're obviously right; the Levine article you posted downthread does an excellent job describing the high-level strategy they employed. Thanks!