Sophisticated systems, software, and advantageous tools and algorithms are utilised to conduct trades in the financial markets. While some activities are conducted publicly, others are conducted in undisclosed marketplaces.
Financial institutions and banks that deal with millions of dollars hold trading sessions, allowing them to take advantage of significant profit opportunities while keeping their activities hidden from competitors.
Private trading markets exclusive to select participants are known as dark pools. Let’s dive deeply into these pools and discover more about them.
Dark Pools’ Concept
Dark pools serve as exclusive platforms where a limited number of companies and investors can discreetly trade and participate in the exchange of diverse securities, including stocks, currencies, commodities, and other asset classes.
The lack of accessibility to secondary market participants has drawn criticism from retail traders and brokerage houses, who find these pools ambiguous.
Nevertheless, the existence of these pools is justified by a significant factor. Consider the scenario where a large corporation worth millions of dollars intends to sell 100,000 shares of stocks from any company it possesses.
Performing this trade in the public market can result in significant market turbulence, triggering more traders to sell their shares and stimulating market signals. As a result, the stock price of the company can plummet significantly.
Such transactions are carried out privately and discreetly to prevent significant market changes from occurring.
What is The Operation Process of Dark Pools?
Although these markets have faced criticism, the US Securities and Exchange Commission regulates them to prevent market manipulation and predatory activities by the participants.
Dark pools operate differently from public markets, as they keep trading activities and transactions hidden from competitors. This is why they are known as dark pools.
These pools are only accessible to big hedge fund firms, financial corporations, and banks that handle large-scale trading and transfer of millions of funds and assets.
A block trade in the dark pool is defined by the SEC as the exchange of tradable asset(s) that has a minimum value of $200,000 or involves trading more than 10,000 shares in the stock market.
Dark pool trades usually exceed the requirements mentioned earlier. These markets have experienced significant growth in the US and now constitute 40% of the total stock market trading.
Selling Points of Dark Pools
Although the pools’ nature may be unclear, they offer significant benefits. Keeping large trading data private from public markets provides several strengths.
No Impact on Public Marketplaces
Trading large quantities in secondary markets can have a significant impact on market prices, leading to substantial changes in prices, trading volumes, and liquidity. These effects can be prevented by executing substantial market orders in private exchanges.
Lower Trading Costs
Trading in dark pools involves fewer middlemen, brokers, and pathways, which results in more reasonable pricing. Additionally, these exclusive exchanges use various trading systems that employ tight spreads and faster execution times.
Higher Liquidity
In private markets, large corporations and institutional investors trading in dark pools have a higher chance of finding a matching order than in public markets. Trading with millions of assets and dollars, dark market participants are more prevalent in these markets.
Privacy
Dark pools allow companies to keep their investments and activities undisclosed by not revealing transaction details to the public or competitors, thus ensuring privacy for the participating companies.
Drawbacks of Dark Pools
Dark pools have always been criticised by public market participants due to their vagueness and the preferential treatment they provide to certain traders. Below are a few drawbacks associated with dark pools.
Unfair Competition
Orders in the dark pool market are typically executed at lower rates compared to secondary markets or the actual market value, resulting in unfair opportunities for gain.
Manipulative Trading Strategies
Although dark pools utilise trading systems that obscure other traders’ information and actions, some participants can manipulate the system.
Dark pools utilise high-frequency trading technologies, which allow traders to execute small orders to gauge the order flow and volume. This enables them to gain an insight into the mid-point market price and dynamics.
Verdict
Buying and selling stocks and other tradable securities in private marketplaces that are only accessible to selected investors and corporations is called dark pool trading. In this type of trading, participants engage in bulk-trading activities that involve buying or selling a large number of shares, such as 250,000.
Executing large orders in dark pools has advantages for the public market, as it helps avoid significant market disruptions. Additionally, it provides companies with a degree of privacy from their competitors.
