Dark Pool Liquidity

What Is Dark Pool Liquidity?

Dark pool liquidity is the trading volume made by institutional orders executed on private exchanges; data about these transactions is generally inaccessible to the public. The bulk of dark pool liquidity is made by block trades worked with away from the central stock market exchanges and directed by institutional investors (essentially investment banks).

Dark pool liquidity is additionally alluded to as the upstairs market, dark liquidity, or dark pool.

Key Takeaway

• Dark pool liquidity is the trading volume made by institutional orders executed on private exchanges.
• Data about transactions that are directed by means of private exchanges — additionally called dark pools — is generally inaccessible to the public.
• The bulk of dark pool liquidity is made by block trades worked with away from the central stock market exchanges and led by institutional investors (fundamentally investment banks).
• Despite the fact that they are legal, dark pools operate with little transparency; thus, dark pools are frequently reprimanded by those in the finance industry who accept that these components pass an unfair advantage on to certain players in the stock market.
• A few traders who utilize strategies that are somewhat founded on the liquidity of the market feel that data about dark pool liquidity ought to be made accessible to the public — and not kept hidden — to make the stock market more pleasant for all gatherings included.

Figuring out Dark Pool Liquidity

The dark pool gets its name since subtleties of these trades are hidden from the public until after they are executed; these transactions are dark like dark, cloudy water. Some traders who utilize strategies that are somewhat founded on the liquidity of the market feel that data about dark pool liquidity ought to be made accessible to the public — and not kept secret — to make the stock market more transparent for all gatherings included.

With the coming of high-speed computer programs, equipped for executing algorithmic-based programs in no time, high-frequency trading (HFT) has come to rule the daily trading volume of the market. HFT is a method of trading that utilizes strong computer programs to execute a large number of orders in parts of a second; as a general rule, traders with the quickest execution speeds are more beneficial than traders with more slow execution speeds.

With HFT, institutional traders can execute their gigantic orders — oftentimes multimillion-share blocks — in front of different investors, permitting them to capitalize on fractional increases or downticks in share prices. When subsequent orders are executed, HFT traders can close out their positions and right away acquire profits. This can happen many times a day and can bring about colossal gains for HFT traders.

During the 1990s, HFT turned out to be unavoidable to such an extent that it became progressively hard to execute large trades through a single exchange. Since large HFT orders must be spread out among various exchanges, the transactions accidentally cautioned trading contenders. Trading contenders would try to get in front of one another, dashing to turn into the primary spot the order; this drove up share prices. And all of this happened inside milliseconds of the initial order that was placed.

To stay away from the transparency of public exchanges and guarantee liquidity for large block trades, several of the investment banks laid out private exchanges, which came to be known as dark pools. Dark pools are a type of alternative trading system (ATS) that offer certain investors the chance to place large orders.

For traders with large orders who can't place them on the public exchanges — or who essentially need to try not to transmit their moves to their rivals — dark pools give a market of purchasers and dealers with the liquidity to execute the trade. As of February 2020, there were in excess of 50 dark pools registered with the Securities and Exchange Commission (SEC) in the U.S.

Analysis of Dark Pool Liquidity

Despite the fact that they are legal, dark pools operate with little transparency. Subsequently, both HFT and dark pools are frequently censured by those in the finance industry; a few traders accept that these components pass an unfair advantage on to certain players in the stock market.

For one's purposes, pundits point out that that the lack of transparency in dark pools can conceal irreconcilable situations. The SEC has likewise moved forward its investigation of dark pools because of grumblings of illegal front-running. Front-running happens when an institutional trader goes into a trade in front of a client's order in light of the fact that the change in the price of the asset will probably bring about a financial gain for the broker.

Then again, promoters of dark pools demand they give essential liquidity, and in this way permit the markets to operate all the more effectively.