What is a ‘Dark pool liquidity’
The dark pool liquidity is the trading volume created by institutional orders on private exchanges and which are mostly unavailable to the public. The main part of dark pool liquidity is represented by block trades contributes away from the Central exchanges. It is also referred to as the “upstairs market,” “dark liquidity” or “dark pool”.
Breaking down the ‘Dark pool liquidity’
The dark pool gets its name because details of these transactions were not hidden from the public until they are executed, which complicates the course of the operation, like muddy water. Some traders that use a strategy based on liquidity feel that dark pool liquidity should be published to make trading more “fair” for all parties involved.
The emergence of dark Pools
With the advent of supercomputers capable of performing algorithmic program during the milliseconds of high frequency trading (hft) has come to dominate daily trading volume. Technology allows hft institutional traders to execute their orders in a multimillion-dollar stock before other investors based on partial or downticks jumps in stock prices. When the subsequent orders are fulfilled, the profits are immediately derived HFT traders who then close their positions. This form of legal piracy can occur dozens of times per day, yielding huge profits for traders HFT.
In the end, HFT has become so pervasive, it becomes harder and harder to execute large trades through a single exchange. Because large orders HFT should be distributed among multiple exchanges, it has alerted the trade of the competitors that could you before ordering and buy up inventory, driving up stock prices. All this happened within a few milliseconds of the first order.
To avoid transparency of public markets and provide liquidity for large batch transactions, several investment banks created private exchanges, which became known as dark pools. For traders with large orders that can not place them on the public exchanges, or want to avoid telegraphing their intention, dark pools represents a market of buyers and sellers with liquidity to complete the trade. In 2016, there are over 50 dark pools operate in the United States, run mostly by investment banks.
Dark Pools Under Scrutiny
Although considered legal, dark pools are able to operate with a low level of transparency. Those who condemned HFT an unfair advantage over other investors also criticized the lack of transparency in dark pools, which may conceal conflict of interest. Securities and exchange Commission (sec) intensified consideration of dark pools for complaints of illegal front-running, what happens when institutional traders place their order in front of the customer, to capitalize on the growth in stock prices. Supporters of dark pools to insist that they provide liquidity, which allowed markets to work more efficiently.