Thursday, February 15, 2007

"Dark Pools"

First, let me thank many people for the feedback I have received about this blog. I have been urged to post some of the “non-internal” summaries that I discuss on investlist in this blog so that external folks can benefit from the information. I am still working on two larger articles; one is a look at Housing moving forward into 2007, and the other discusses the mechanics of 401K portfolio creation.

Many people have asked in the past, “How are brokerage firms able to trade stocks outside the market?” The answer is “Dark Pools”.

Basically big institutions have long sought the ability to anonymously trade large blocks of stock with minimal market reaction. This has made so-called “dark pools”, essentially a secretive matching system for large orders, a growth market. LiquidNet, Nyfix Millenium and other firms have started-up over the past couple years that provide this capability, more are announced every month.

The daily volume of these firms that provide "dark pool" capability has risen rapidly. Many brokerages and exchanges want to get in on this trend. NYSE, Nasdaq and the International Securities Exchange have all said they would pursue the niche. Nasdaq is offering its Intraday Cross for free for a limited time.

The key issue to the investor regarding these “dark pools” is the lack of transparency. Your order may be implemented as part of a block outside the public market, and the information from “dark pools” are not displayed as public pricing information. This will likely lead to you not getting the best price for your shares.

It is easy understand why the exchanges would want in on these crossing networks; utilization of “dark pools” for crossing large blocks are causing their public volume to drop. The lack of transparency for these types of block trades when implemented by an exchange still must be troubling to regulators however; the entire purpose of an exchange is to promote an open market. Broker-dealers would even have a tougher time getting regulatory approval to act as a principal in this market, as well as competitive concerns about information advantage.

Some Articles

Diving Into Dark Pools

Dark Pool and Crossing Network Volumes to Triple to 1.5 Billion Shares a Day in 2010, Says TABB Group

The Evolving Block Trade

Hidden Orders and Dark pools Are Taking Order Secrecy on Wall Street to a New Level

Dark Pools and the Tactical Side of Trading