Dark pool is a term used to describe trades that occur in the dark and away from the public eye. As opposed to normal security exchanges, they are not traded through a public stock exchange – such as NASDAQ or the NYSE.
Dark pool is also known as the “upstairs market” or “dark liquidity”. They are called ‘dark’ because the price is revealed only after the whole trade has been done. About one-eighth of the US stock market’s volume is believed to consist of dark pool activity.
Most of these trades that occur in dark pools are carried out by large financial institutions who want to make trades anonymously and not cause a major shake in the market – which could undermine their selling price.
By trading large amounts of securities without the whole market knowing, there is no market reaction to the transaction(s).
If everybody knows the pension fund plans to sell a huge number of shares, the price of those shares will fall considerably. So its bank sells the shares through a dark pool, in bits – nobody notices.
Dark pools keep us in the dark
However, surely there must be some disadvantages to trading in the dark and away from public view? The answer is ‘yes’.
Dark pools keep individual investors unaware of what is really happening in the market.
When large financial institutions (such as pension funds) sell billions of dollars worth of stock without people knowing, the market is no longer transparent – which defeats the whole point of having public stock exchanges.
Many people say that dark pool liquidity should be available for the public to see – thus making sure a fair trading environment is maintained.
“In dark pools, pre-trade prices – the price at which shares are offered for sale – are not visible to anyone, even the participants in them, and the price at which shares change hands is only revealed after the trade is done.”
How common and popular are dark pools?
According to an MIT study, dark pools are becoming more common in stock trading. In fact, researchers found that they currently account for around one eighth of all stock trading volume in the US. Most experts believe volumes are similar in Europe.
Many economists are alarmed at this huge chunk of hidden activity. A survey found that 71% of finance professionals consider dark pools to be ‘somewhat’ or ‘very’ problematic in setting stock prices.
However, Haoxiang Zhu, a financial economist at the MIT Sloan School of Management, believes that in some cases, dark pools can actually help price discovery.
According to Zhu:
“The dark pool is like a screening device that siphons off uninformed traders. In the end, on the [public] exchange, you get left with a higher concentration of the informed traders who contribute to price discovery.”
List of dark pools
- BIDS ATS
- LX Liquidity Cross
- ALPHA Y
- Aqua Securities
- BATS Trading
- BNP Paribas Internal eXchange (BIX)
- BNY ConvergEx Group
- Citi Match, Citi Cross
- ETF One
- International Securities Exchange
- Knight Link, Knight Match
- LeveL ATS
- Nomura NX
- NYFIX Millennium
- NYSE Euronext
- Pulse Trading BlockCross
- SIGMA X
- SuperX ATS
- TORA Crosspoint
- UBS ATS, UBS MTF, UBS PIN
Video – Dark Pools. Should we worry about them?