What is Dark Pool Trading? – Introduction

Many people are asking the question - what is a dark pool? Where does it fit into the world of finance? Dark pool trading takes place in an environment similar to an exchange which allows for the private trading of securities. Large amounts of stocks, estimated to be around 15% of total trading volume in the US, are offered away from public exchanges in these dark pools. The very name dark pool comes from the lack of transparency that is the hallmark of these trading arenas. It is in fact, this confidentiality that draws most investors to trade in a dark pool. The majority of dark pool trades are block trades conducted by financial institutions. The greatest benefit of making these trades in a dark pool is that the market is not influenced by the placing of a large order, and therefore the price is not affected.

The Origin of Dark Pools

Dark pools came into existence in the 1980s, and the decentralization of physical trading venues along with the increased prevalence of electronic trading with the use of electronic exchanges has been instrumental in allowing this to happen. It is actually suggested that this dark pool type of trading has been around longer than when it was given the name in the 1980s, and that it was previously known as “upstairs trading”.

How to Access Dark Pools

Some dark pools are accessed through a system called a crossing network. A crossing network is an electronic trading system that matches buy and sell orders without making these orders public. Dark pools may also be entered by private contractual arrangement, and there are others that are accessible to the public through a retail broker.

What is a Dark Pool Structure?

Some dark pools are independent companies whose specific purpose is the providing of an anonymous trading environment. Other dark pools are created through a broker, to facilitate undisclosed trading between the clients of the broker. Finally, there are dark pools which are operated by exchanges, offering their clients the privacy of unidentified trading, but with some of the structure of regular exchange trading.

What is a Dark Pool Safety Level?

Contrary to the often-held belief that there is something shady about dark pool trading, dark pools are actually highly regulated. All dark pool operators are registered with the SEC and they are controlled in the same manner as an exchange, with periodic audits and inspections.

What is a Dark Pool Scandal?

Dark pools have been attracting attention and controversy in the media, with one especially prominent example being the lawsuit filed against Barclays in June 2014. The lawsuit, filed by New York Attorney General Eric T. Schneiderman listed several complaints about the banking group’s dark pool operations. These included the falsification of data relating to the number of high-frequency traders involved in the dark pool, and the improper use of confidential customer information.

Benefits of Dark Pool Trading

The biggest benefit of trading in a dark pool is that the market is not affected by the disclosure of a large order as it would be on a public exchange. This means that the trader frequently has the chance of attaining a better price than on an exchange trade.

An institutional trader seeking to sell a large block of shares often has a better possibility of finding a buyer for the whole block of shares as dark pools specifically attract big investors.

The costs incurred by trading in a dark pool may be reduced as a result of saving on exchange fees.

Drawbacks to Dark Pool Trading

If information is leaked, then the advantage of the undisclosed trading offered by a dark pool is rendered inapplicable. This may further be compounded if the dark pool is frequented by traders who seek to prey on any hint of trading intelligence using practices such as front-running.

Situations such as in the lawsuit against Barclays may put a trader at a disadvantage if the dark pool is not adhering to good business practices.

A Final Word on What is a Dark Pool in Trading

A dark pool in trading is a private trading arena which allows for undisclosed trading that may offer advantages, especially to institutional traders of large blocks of shares. While there is some controversy surrounding these alternative trading venues, they continue to attract a large amount of participation, indicating that for certain types of trading, off-market is a viable way to trade.