Anyone familiar with this Dark Pools problem?

[Brendan Burgess]

I have been trying to understand the case against Barclays and what Dark Pools are. The Wikidpedia article is a good introduction.

I presume that they are only relevant to traders i.e. large institutions who buy and sell shares frequently. Have they any implication for long term buy and hold investors?

A seller will sell where the price is best and the costs are lowest. Why would they trust the operator of the dark pool not to take advantage of the fact that they are a big seller?

 

[peno]

Michael Lewis latest book Flash Boys goes into detail on this. it's about high frequency traders and dark pools.

As you suggest it's really just buying and selling that is affected and long term investors shouldn't be affected until of course you go to sell - and are in the pool.

Also you need to be a large trader/institution to sign up to these funds - the average joe shouldn't be affected in the pool but will be by the high frequency traders in the market.

that's my simple view.

 

[Seagull]

Dark pools don't really have any impact on the small investor. They are typically used by large financial institutions to sell large holdings without impacting the market. As for why they would trust the operator - are you going to try to screw over a client who's putting several billion dollars worth of trades through your system every month. Also, in some cases, a dark pool is run by the members.

 

[Sunny]

Dark pools don't really have any impact on the small investor. They are typically used by large financial institutions to sell large holdings without impacting the market. As for why they would trust the operator - are you going to try to screw over a client who's putting several billion dollars worth of trades through your system every month. Also, in some cases, a dark pool is run by the members.

Not necessarily true. Mutual funds which are full of retail investors are part of dark pools. They are not just large financial insitutions doing prop trading. Some banks as far I know will also route retail orders through their dark pool before sending them onto the open market if there isn't a fill.

Brendan, going back to your question, good luck trying to get to the bottom of it! I don't think the banks even understand it.

The whole idea of a dark pool is that no-one is aware that there is a large seller or buyer out there. The operator of the pool will know and people need to be aware of information leakage but the regulator would close the pool down if it was proven that the pool operator was abusing it's position. As far as I understand it, if I place a large order to buy 10000 shares in XYZ, nobody sees that I want to buy 10000 shares. If there isn't a seller of 10000 shares out there, the order will be filled piecemill in smaller chunks until a large chunk becomes available. In a normal exchange, you would have to advertise that you buying 10000 shares or break up the order into smaller lots so that traders won't move the price against you. This can be costly and inefficent. That's the positive side of dark pools.

The concerns are that as liquidity in these pools increased, they attracted the interest of high fequency traders using computer algorithams to trade. What these guys will do is continuously test the market by sending out a rapid string of small offer lots to see if there is a buyer. If they are continuously having their orders filled, they can work out that there is a big buy order in the pool. They can then replicate the trade and game the original buyer. Most dark pools say that they have measures to prevent this but I wouldn't be convinced.

The issue with Barclays as far as I know is that they reassured clients that these high frequency traders did not have access to the pool when infact they did. Slower investors like mutual funds who throught they were dealing with similar investors were actually trading with a very different animal. There were also concerns about how Barclays diverted orders into the dark pool instead of to other exchnages that might have offered a better price.

That's a very simplistic take on it...............

 

[Brendan Burgess]

Thanks Sunny for such a comprehensive answer.

I think Seagull was correct in that he was answering my question " Have they any implication for long term buy and hold investors? " which means the guy like me who buys shares directly and holds them for the long-term.

 

[Sunny]

Thanks Sunny for such a comprehensive answer.

I think Seagull was correct in that he was answering my question " Have they any implication for long term buy and hold investors? " which means the guy like me who buys shares directly and holds them for the long-term.

Even as a long term buy and hold investor, you still need to buy the shares and you will still need to sell them. If you are dealing shares through a broker, then you might want to check their best execution policy to see if they allow orders to be filled in this way. Most I would be willing to bet do. BTW, it's not necessarily a bad thing.

 

[Seagull]

Not necessarily true. Mutual funds which are full of retail investors are part of dark pools. They are not just large financial insitutions doing prop trading.

I include mututal fund companies as large financial institutions. The individual investors might be small, but the companies are not. I also didn't say anything about it being only for proprietary trading.

In many cases, only members of a dark pools can trade in there. If an order can't be met there, or can only be partially filled, it will then have to go out into the open markets.

 

[Rory Gillen]

I have been trying to understand the case against Barclays and what Dark Pools are. The Wikidpedia article is a good introduction.

I presume that they are only relevant to traders i.e. large institutions who buy and sell shares frequently. Have they any implication for long term buy and hold investors?

A seller will sell where the price is best and the costs are lowest. Why would they trust the operator of the dark pool not to take advantage of the fact that they are a big seller?

Brendan,

The implications of dark pools and high-frequency trading are more serious for the short-term trader than the long-term investor but there is scalping involved either way which has been rightly described as predatory behaviour or front-running and most likely illegal in nature.

I did an article on high-frequency trading a while back if of any interest. See link.

[broken link removed]

Rory Gillen

 

[Sunny]

I include mututal fund companies as large financial institutions. The individual investors might be small, but the companies are not. I also didn't say anything about it being only for proprietary trading.

In many cases, only members of a dark pools can trade in there. If an order can't be met there, or can only be partially filled, it will then have to go out into the open markets.

You said that they don't impact small investors but that is not necessarily true. As well as maybe getting ripped off through their pensions or investments, many small investors who dabble in the stock market could end up have their trades settled in dark pools. Brokers use different venues for executing trades. Some will only use regulated exchanges but others won't or at least not directly. For example, I could decide to buy IBM shares through TD direct. They use multiple exchanges to obtain the best price but they only use regulated exchanges. One of the venues they use for US equities is Citigroup who are a regulated venue. Citigroup will direct any unfilled trades that they can't fill into their dark pool. If it remains unfilled, it will then go to the open market.

None of this is necessarily bad if people are getting the best price but dark pool's account for an increasing number of trades and the trade sizes are small. Just because a small individual investor doesn't know they are trading in dark pools doesn't mean they aren't. Most people aren't even aware that that securities can be traded on multiple competing exchanges. They think trades just happen in stock exchanges.