I have been hearing about high frequency trading for a long time, but didn't really understand what they were doing for quite a while. A few years ago I read an explanation of how the programs detect large orders and front-run these large orders. More recently I read a book called "Dark Pools" by Scott Patterson which covers a lot of the same ground as Michael Lewis' new book. I love Michael Lewis as an author and can't wait to read his book. I think these guys (HFTs) can trade in fractions of a penny, so if a large portfolio has a resting order to buy 100,000 MSFT at 39.25, even if the price comes down to that level, after 100 or so shares trade at 39.25 and the HFT detects a huge bid there, he can buy shares at 39.251 and try to sell them at 39.26.
I understand that many portfolios make large buy/sell decisions and then go to the market to execute the trades, undisguised, but I don't understand why a hedge fund trader wouldn't do more spoofing to try to outfox the HFT, for example by flashing a large bid and then putting an offer one cent higher. The HFT thinks there is a buyer in the market, so buys your shares, when you are actually a seller. This is how I was taught to trade (institutionally). If you want to sell something, the first thing you must do is show a bid, which tells the market there is buying interest. We also would routinely front run customers. It was a matter of self preservation. If a customer showed himself to be a large buyer, I would have to go to the market and buy buy buy.