What Is A Dark Pool And Why Are People Trading In Them?
- Thread starter OnClose
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At high speeds, our good friends Heisenberg and Einstein ensure that every venue is, in reality, a dark pool.
How does being in a dark pool benefit anyone?
Let's say I want to sell my car. I could post it on craigslist with a price. Or I could put a sign on it and park it in my garage and wait for someone to knock on my door and make me an offer. Which would net me a better price for what I want to sell?
I could see that the guy checking a dark pool might be at an advantage by scooping up / unloading shares that are mispriced, but why would anyone take the other side of that trade?
Can someone explain this like I'm a five year old?
Let's say I want to sell my car. I could post it on craigslist with a price. Or I could put a sign on it and park it in my garage and wait for someone to knock on my door and make me an offer. Which would net me a better price for what I want to sell?
I could see that the guy checking a dark pool might be at an advantage by scooping up / unloading shares that are mispriced, but why would anyone take the other side of that trade?
Can someone explain this like I'm a five year old?
My guess is that some institutions don't want to show their hands, thus they are willing to take a worse price than what the market offers. Otherwise there is no point in taking the other side.... Or there could be a huge buyer and also a huge seller in the same security, and without each other, they would affect the price, what neither of them want to do...
If you really want the details:
http://en.wikipedia.org/wiki/Dark_liquidity
"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."
I think a dark pool is where people trade, but can't make enough to liveoff of so they start cutting back on expenses.
Here is a hypothetical situation for you. Suppose you are a large bank that has two departments, one that offers 2.95 trading commissions (lowest in the industry) and one that holds directional positions in the market.
Joe DayTrader decides to sell 1000 shares of X and buy them back later on. Likely you have some X in your trading inventory. Swap the trader in and out later that day (a book entry from your own inventory) and pocket a cool 5.90 plus fees for doing it. Note that no stock changes hands, the two departments simply have an imbalance. It must be squared sometime but with lots of Joes, you need to balance say quarterly.
Your actual directional positions, can't be known for certain since you have not traded externally. You can trade against the Joes if your own directional position happens to be opposite. You can trade with them and use Joe to hedge later on if you like. You can simply play Joe vs Joe if you like under the guise of helping them trade.
Oh yeah. Suppose you end up missing 50000 shares of X and forgot to manage your own inventory. Quarter end is coming up and it is time to square up. You simply place an order for 5000 shares of X and pay 2.95 ( not really likely) with a stock wholesaler for the whole lot.
All in all, you have made thousands of dollars to offset your costs and continued to pursue your own trades. Does that give you some idea of the possibilities?
Here is some homework for you. Certain types of trading would be illegal if done under the auspices of the regulatory bodies. Would the same regulatory issues occur on paper transfers? Who would report a violation?