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More and more trades are being executed in off-the-grid exchanges called ‘dark pools’, reports Fox Business News’ Charlie Gasparino. For the first time, volume in those exchanges eclipsed trading volume in the New York Stock Exchange.In January, the 19 dark pools in the U.S. saw an average daily trading volume of 920 million, NYSE’s figure was around 900 million trades.
Dark pools started back in the 1980s. The idea was to create more anonymous places where big institutional investors could trade away from the eyes of everyone in the public exchanges and without making an impact on market prices. In 2007, SEC Regulation called REG NMS made it possible for anyone to start a dark pool, so investment banks jumped in the game.
Now about 12% of trades are executed in dark pools. Maybe more.
The problem with dark pool trading is simple — it lacks transparency. When you enter a dark pool you don’t know who you’re trading with or if they want what you’re trading at the price you’re willing to trade it.
That said, there are two ways that people decide to enter dark pools.
- Some brokers cut “payment for order flow” deals, which are agreements to send orders to a certain dark pool.
- Then there are things called “indications of interest” (IOI). They’re the dark pools’ version of a quote. The IOIs can contain any mix (but not all) of the following pieces of information — the ticker of stock, the buy/sell interest, the price, or how much is up for grabs. They’re not public either.
There is an MIT study that says Dark Pools widen spreads between bid price and an offer price for stocks on open exchanges, so that’s another drawback.
Beyond that, the anonymity of the dark pools ensures that if something goes wrong inside one of those exchanges, we don’t know who made the mistake.
Here’s one perfect example: Back in October there were at least 258 bad prints in 146 stocks that came from an automated trading program managed by a dark pool. Those stocks went insane for about an hour and we don’t know who was at fault.
People were calling the shock a “mini Knight,” after the horrible day last summer when Knight Capital lost $400 million in half an hour because a faulty trading program.
And no one wants that again.
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