http://online.wsj.com/article/SB1000142405274870395760457527...
Also, the main reason many HFTs pulled out of the market is the risk of broken trades (regulatory risk [1]). Staying in the market would have been a big moneymaker absent that risk - spreads were often huge.
But broken trades were dangerous. If you buy accenture at $1.00, and sell at $30.00, you've helped fix the flash crash. You also just lost $10.00 - your $1.00 trade was broken, and you now have a short position you bought at $30.00 (Accenture recovered to $40.00, so you lost $10.00/share).
[1] Regulation by the exchanges, not the SEC. Maybe there is an SEC regulation mandating they do this, but I have no knowledge on that point.
The SEC/CFTC report on the 2010 Flash Crash describes how it happened. Quote:
One key lesson is that under stressed market conditions, the automated execution of a large sell order can trigger extreme price movements, especially if the automated execution algorithm does not take prices into account. Moreover, the interaction between automated execution programs and algorithmic trading strategies can quickly erode liquidity and result in disorderly markets.
http://www.sec.gov/news/studies/2010/marketevents-report.pdf
Of course you can make a huge profit when a crash occurs, whether that crash is due to a vicious circle of algorithms, or a vicious circle of human psychology. There are algorithms out there that look to do just that, trying to profit from exploitable market anomalies, and it's great that those people have found a way to get paid for fixing some problems. But they're not HFT market-makers, they're a different group of quant/algo traders.
Personally I care little about HFT. The flaws in the technology will get ironed out; the competition for the low-hanging fruit will continue to intensify, and eventually many of the functions will become commoditized as they mature.
In the meantime, I think it makes sense for HFT market participants to be sensitive to the fact that many individual market participants have trouble identifying the value they've received because of HFT participation, but can clearly remember fears that have been induced by HFT driven events.
The HFT could have placed a passive buy order at $1.00 and a sell at $30.00 (or at $2.00, which he revised upwards as the price corrected).
Yes, some people living on the edge of the market, picking pennies in front of steam rollers, probably had a few days shaved off their life expectancies due to adrenalin spikes, but I could really care less.
The most substantial costs were probably borne by unlucky individuals who had stop-losses that executed solely due to the downward spike, and afterwards found themselves facing a loss, and possibly a tax bills, but I have no idea how common that situation was. I do know that one of my close friends booked his career best day that day, so surely there were also some people who took substantial losses because they didn't expect the problem that occurred.
HFTs thrive in volatile markets. not calm markets. Those HFT firms that stayed in the market during the flash crash made a killing.
We ran into a situation where the market was already volatile, and a bad trade exacerbated the issue by causing a number of HFTs to take unexpected losses and withdraw from their markets, consuming further liquidity while driving prices down, which created more losses for the remaining market-makers, who had to close their positions, consuming further liquidity, driving prices further down; all of those also negatively affecting long-term investors.
This also seemed to me an example of the opportunism of HFT, where the HFT shaves the spread by a penny or two during calm markets, but withdraws (and exacerbates issues) during volatile and troubled markets, which seems to me the point in time at which liquidity provision is most valuable.
I'm not suggesting that HFT should be outlawed, nor that HFT firms should be forced to register, act, and be regulated as official market-makers, with the associated duties.
But I do note the benefits seem to come with costs.
Long-term, I doubt it matters. It seems inevitable that the provision of liquidity will become commoditized, and that the days of concerns about flash crashes will eventually disappear into the past along with $50 retail trades, and $0.50 bid/ask spreads.