Dark Pools: The Hidden Stock Markets
The Need for Hidden Stock Markets
Suppose you are an Angel Investor planning to sell 30,000 stocks to fund your next real estate venture. Instinctively you plan to sell them on an open Exchange, but you are worried about price loss since large-scale sales of stock alert investors in the market, shifting market demand and pulling the price down. That’s where Dark pools come in. Dark pools offer opaque private transactions with price limits and guarantee an average price for the sale of the whole block. Dark pools are private exchanges that big investors specialize in block trading who want to leave a minimal footprint on Open Markets. Zero transparency gives institutional investors who work for individual clients a scheme to get the best value for their shares, which otherwise will plummet in a transparent market. Dark pools allow investors to set a fixed base price for the stocks they want to sell. This will enable investors to set all their stocks at an even price and guarantee zero price volatility. In a traditional exchange, transactions work based on market-orders which assures instant trade but with price devaluation, but Dark pools work based on limit-orders where trade occurs with a fixed, user-specified price limit for all stocks over an extended period with the least stock devaluation.
Who Operates Them?
Many Investment Banks opened their Dark pools for their clients to trade in shadow. Some of these include Goldman Sachs’ SigmaX and Morgan Stanley’s MS PooI. Crypto trading firms like Kraken have also pitched in Dark pools for trading Bitcoin and Ethereum. In 2017, Dark pools accounted for about 40 percent of stock trades in the US. The average stock order size decreased from 430 shares in 2009 to 200 shares in 2013 due to large block trades moving to Dark pools. Even though Dark pools benefit big traders, it puts retail investors and algorithmic traders at a disadvantage. With Dark pools growing and gobbling up large shares of trades, investors are worried that public stock exchanges like London Stock Exchange and Nasdaq no longer reflect the actual value of stocks and securities. Another disadvantage is that predatory techniques like Front Running are legal in Dark pools. An instance of Front Running is when a trader finds out that you’re about to buy some stock and immediately buys it in his portfolio and sells them back to you at a higher price.
Are Dark pools only for big investors? The answer is no. Dark pool exchanges need more traders to trade in them to ensure the liquidity of stocks where there are many price options for investors to deal with. Dark pools have now opened up separate channels for small-sized trades and retail investors. Recent High-Frequency Trading controversy on Front running and predatory trading practices have put Dark pools in the bad spotlight while regulatory bodies are closing in to address transparency issues of Dark pools. With the eerie name it carries, Dark pools may sound menacing to investors, but they are tightly regulated by bodies like US Securities and Exchange Commission. Open Exchanges are worried about the external influence of Dark pools and are insecure that Dark pools might compete with them in the future. Nevertheless, Dark pools are here to stay, and regulations will alter the way they operate.