For sure, HFTs don't have crystal balls. They certainly are able to leverage their market access to give them an advantage, though.
I feel like I need to reiterate that I don't think HFT is evil. I'm just not sure that HFTs really add that much liquidity to the market, and there is evidence that they contribute to volatility (such as the flash crash).
The "Flash Crash" was caused by a single, manually-initiated large block trade:
At 2:32 p.m., against this backdrop of unusually high volatility and thinning liquidity, a large fundamental trader (a mutual fund complex) initiated a sell program to sell a total of 75,000 EMini contracts (valued at approximately $4.1 billion) as a hedge to an existing equity position.
(From the SEC link Chris posted earlier).
I don't know whether I believe Chris that HFTs caused the market to correct much faster, but it seems clear that HFT didn't cause the crash.
The SEC seems to disagree, and says that HFTs added to the drop. HFTs also apparently burned through about half of the trading volume just trading with each other.
> The combined selling pressure from the Sell Algorithm, HFTs and other traders drove the price of the E-Mini S&P 500 down approximately 3% in just four minutes from the beginning of 2:41 pm through the end of 2:44 pm. During this same time cross-market arbitrageurs who did buy the E-Mini S&P 500, simultaneously sold equivalent amounts in the equities markets, driving the price of SPY (an exchange-traded fund which represents the S&P 500 index) also down approximately 3%.
> Still lacking sufficient demand from fundamental buyers or cross-market arbitrageurs, HFTs began to quickly buy and then resell contracts to each other – generating a “hot-potato” volume effect as the same positions were rapidly passed back and forth. Between 2:45:13 and 2:45:27, HFTs traded over 27,000 contracts, which accounted for about 49 percent of the total trading volume, while buying only about 200 additional contracts net.[9]
HFT didn't cause the flash crash, but neither did that mutual fund manager.
The primary cause was a delay in when incoming orders were time-stamped by the NYSE. Instead of stamping the orders when they arrived at the queue just before entering the market, the NYSE servers time-stamped them when they _left_ the queue and were placed in the book.
Since the queue was delayed by extreme volume (NYSE has always lagged on technology), stale prices were posted to the NYSE feed. However, it was impossible to tell that they were stale from the timestamps.
Since the market was falling rapidly, this resulted in the NYSE quoting higher prices than every other market.
Since the NYSE was quoting higher prices than every other market, arbitrageurs massively sold at the NYSE and bought on other exchanges.
Since the queue was delayed, however, the sell orders at the NYSE took a while to actually show up in the book. Meanwhile, more sell orders were placed.
I feel like I need to reiterate that I don't think HFT is evil. I'm just not sure that HFTs really add that much liquidity to the market, and there is evidence that they contribute to volatility (such as the flash crash).