Dark Pools

A dark pool is a private trading venue that does not show its order book to the public. Buyers and sellers submit orders without anyone else seeing their size or price, and trades are only reported after they happen. Dark pools exist mainly so that institutions can trade large blocks of shares without revealing their intentions and moving the price against themselves.

Why dark pools exist#

Imagine a pension fund that wants to sell 500,000 shares. If it posts that order on a public exchange, other traders see a large seller and may sell ahead of it or lower their bids, pushing the price down before the fund finishes. In a dark pool, the order sits hidden. If another participant wants to buy a large amount, the two can trade without either revealing their size to the wider market. See Market Impact.

How dark pools work#

Many dark pools match orders at the midpoint of the national best bid and offer taken from public exchanges, so both sides save half the spread. They depend on lit exchanges for their reference prices. See Pegged and Midpoint Orders.

Who operates them#

• Broker-dealer pools run by large banks and brokers, matching client orders internally.
• Agency and independent pools owned by firms that do not trade for themselves.
• Exchange owned pools run by exchange groups.
• Block trading venues specialising in very large trades.

How much trading is dark?#

A significant share of US stock volume happens off exchange, including dark pools and wholesale market makers that internalise retail orders. Off exchange trading has at times exceeded on exchange trading for US stocks. FINRA publishes weekly volume statistics for each alternative trading system.

Concerns about dark pools#

• Price discovery: if too much trading happens out of sight, public prices may reflect less information. See Price Discovery.
• Fairness and conflicts: some operators have been fined for misleading clients about how their pools worked, for example about the presence of high frequency traders or how orders were routed.
• Information leakage: fast traders may probe dark pools with small orders to detect large hidden orders.
• Complexity: dozens of venues with different rules make it harder for investors to know where and how their orders execute.

Regulators have responded with more reporting requirements, such as Form ATS-N disclosures in the US describing each pool's operations.

What dark pools mean for you#

Retail orders usually reach dark pools only indirectly, through broker routing or wholesale market makers. You may see dark pool trades on time and sales or as large prints after the fact. Some traders watch large off exchange prints as clues to institutional activity, though interpreting them is difficult. For most individual traders, the practical effect is that some of the liquidity in a stock is not visible in the order book. See Order Routing and Smart Order Routing and Hidden and Iceberg Orders.

Frequently asked questions#

Are dark pools legal?#

Yes. In the US they operate as regulated alternative trading systems and must report trades and register with the SEC.

Why are they called dark pools?#

Because their order books are not visible, or "lit", to the public before trades take place.

Do dark pools affect stock prices?#

They can, indirectly. Large trades still affect supply and demand, and heavy dark trading can reduce the information in public quotes.

Sources#

• FINRA, OTC transparency data
• Wikipedia, Dark pool