What is ‘Dark Pool Liquidity’
Dark pool liquidity is the trading volume created by institutional orders executed on private exchanges and unavailable to the public. The bulk of dark pool liquidity is represented by block trades facilitated away from the central exchanges. It is also referred to as the “upstairs market,” “dark liquidity” or “dark pool.”
Explaining ‘Dark Pool Liquidity’
The dark pool gets its name because details of these trades are concealed from the public, clouding the transactions like murky water. Some traders who use a strategy based on liquidity feel that dark pool liquidity should be publicized to make trading more “fair” for all parties involved.
The Emergence of Dark Pools
With the advent of supercomputers capable of executing algorithmic-based programs over the course of just milliseconds, high-frequency trading (HFT) has come to dominate daily trading volume. HFT technology allows institutional traders to execute their orders of multi-million share blocks ahead of other investors, capitalizing on fractional upticks or downticks in share prices. When subsequent orders are executed, profits are instantly obtained by HFT traders who then close out their positions. This form of legal piracy can occur dozens of times a day, reaping huge gains for HFT traders.
Dark Pools Under Scrutiny
Although considered legal, dark pools are able to operate with little transparency. Those who have denounced HFT as an unfair advantage over other investors have also condemned the lack of transparency in dark pools, which can hide conflicts of interest. The Securities and Exchange Commission (SEC) has stepped up its scrutiny of dark pools over complaints of illegal front-running that occurs when institutional traders place their order in front of a customer’s order to capitalize on the uptick in share prices. Advocates of dark pools insist they provide essential liquidity, allowing the markets to operate more efficiently.
- Dark pool trading strategies, market quality and welfare – www.sciencedirect.com [PDF]
- Diving into dark pools – papers.ssrn.com [PDF]
- Do dark pools harm price discovery? – academic.oup.com [PDF]
- The dark side of liquidity: shedding light on dark pools' marketing and market-making – www.tandfonline.com [PDF]
- Into the light: dark pool trading and intraday market quality on the primary exchange – papers.ssrn.com [PDF]
- Shedding light on dark liquidity pools – papers.ssrn.com [PDF]
- Dark pool exclusivity matters – papers.ssrn.com [PDF]