In finance, dark pools of liquidity (also referred to as dark liquidity
or simply dark pools or black pools) is trading volume or liquidity that
is not openly available to the public.[1] The bulk of these represent
large trades by financial institutions that are offered away from public
exchanges so that trades are anonymous. The fragmentation of financial
trading venues and electronic trading has allowed dark pools to be
created, and they are normally accessed through crossing networks or
directly between market participants.
One of the main advantages for
institutional investors in using dark pools is for buying or selling
large blocks of securities without showing their hand to others and thus
avoiding market impact as neither the size of the trade nor the
identity are revealed until the trade is filled. However, it also means
that some market participants are disadvantaged as they cannot see the
trades before they are executed; prices are agreed upon by participants
in the dark pools, so the market becomes no longer transparent.[2]
There
are three major types of dark pools. The first type is independent
companies set up to offer a unique differentiated basis for trading. The
second type is broker-owned dark pools where clients of the broker
interact, most commonly with other clients of the broker (possibly
including its own proprietary traders) in conditions of anonymity.
Finally, some public exchanges are creating their own dark pools to
allow their clients the benefits of anonymity and non-display of orders
while offering an exchange "infrastructure". Depending on the precise
way in which a "dark" pool operates and interacts with other venues it
may be considered, and indeed referred to by some vendors as a "grey"
pool.
Whilst it is safe to say that trading on a dark venue will
reduce market impact, it is very unlikely to reduce it to zero. In
particular the liquidity that crosses when there is a transaction has to
come from somewhere—and at least some of it is likely to come from the
public market, as automated broker systems intercept market-bound orders
and instead cross them with the buyer/seller. This disappearance of the
opposite side liquidity as it trades with the buyer/seller and leaves
the market will cause impact. In addition, the order will slow down the
market movement in the direction favorable to the buyer/seller and speed
it up in the unfavourable direction. The market impact of the hidden
liquidity is greatest when all of the public liquidity has a chance to
cross with the user and least when the user is able to cross with ONLY
other hidden liquidity that is also not represented on the market. In
other words, the user has a tradeoff: reduce the speed of execution by
crossing with only dark liquidity or increase it and increase his market
impact.
One potential problem with crossing networks is the
so-called winner's curse. Fulfillment of an order implies that the
seller actually had more liquidity behind their order than the buyer. If
the seller was making many small orders across a long period of time,
this would not be relevant. However, when large volumes are being
traded, it can be assumed that the other side—being even larger—has the
power to cause market impact and thus push the price against the buyer.
Paradoxically, the fulfillment of a large order is actually an indicator
that the buyer would have benefitted from not placing the order to
begin with—he or she would have been better off waiting for the seller's
market impact, and then purchasing at the new price.
http://en.wikipedia.org/wiki/Dark_pool
