What’s a dark Pool?
Dark Pools are not dwelling places for sea monsters, they are actually exchanges where shares are bought and sold, the difference between Dark Pools and other trading markets is that they’re not public, you simply can’t tell who’s buying and who’s selling, so the trading is done in the dark, unless until after the trade has been executed and reported.
Dark pools give certain investors the opportunity to place large orders and make trades without revealing their intentions during the search for a buyer or a seller. This prevents heavy price devaluation which would otherwise occur.
Also it can charge lower fees than exchanges because they are often housed within a large firm and not necessarily a bank. However, they are no longer used only for large orders.
Types of Dark Pools:
There are three kind of Dark Pools:
Broker-Dealer-Owned Dark Pool; They are set up by large broker-dealers for their own proprietary traders. As prices derived from order flow there is an element of price discovery.
Agency broker or Exchange-Owned Dark Pool; These are Dark Pools that act as agents, not principals. As prices are derived from exchanges there is no price discovery.
Electronic Market Makers Dark Pools; Offered by independent operators who operate as principals for their own accounts, their transaction prices are not calculated so there is no price discovery.
Why use dark Pools?
Let’s take an example to simplify things;
So we’ve got a seller and a buyer.
let’s say that the seller runs a large pension fund and got a large block of shares that he wants to sell which brings the attention of people to him, they watch him carefully to see what would he do because he can be kind of a bellwether for the market.
The seller has a large amount of money, that would send the message itself and move the market and when you chuck a large amount of shares in one go it creates a ripple and impair what the seller would be able to sell.
So what he does is break the block down in order to sell it because it’s difficult to find somebody who would take that much in one go.
As the seller pushes the shares into the market as he creates a technical pressure which pushes the price down so maybe in the end he would gain much less than if he sold it in one go.
And that’s where the dark pool gets in, the seller whispers in the electronic system that he has a large blog of shares to sell and the system whispers back by matching him anonymously with a buyer.
The same thing for the buyer, it’s difficult to find a seller who would sell a large blog of shares that the he simply would need.
But is it an advantage to all traders?
Criticism of Dark Pools:
Although the Dark Pool is legal, they operate with little transparency, very little oversight.
Some traders believe that it conveys an unfair advantage to certain players in the stock market.
For example, the Dark Pools are generally used by large institutional investors and people with large amount of money. Individual investors or smaller investors who want trading are then kind of left on the sidelines.
There are two concerns:
One is that these Dark Pools are taking energy and activities away for other trading markets. Two is that as these Dark Pools take up space and become more numerous, most of the activities is going into the dark which takes power and knowledge from the public to be able to transact with own sales and shares. Which leads to regulating dark pools.
