While dark pools are legal, they have come under regulatory scrutiny because of their lack of transparency. Sometimes ATS/dark pool operators have engaged in dishonest behavior—like front-running orders (tipping off other traders about a dark-pool trade)—that’s led to enforcement from the U.S. These firms operate strategies which typically trade thousands of times per day, and thus benefit from minor savings in price and fees versus routing orders through a public stock exchange.

The SEC closely regulates alternative trading systems, or what are colloquially known as dark pools. In fact, the SEC has updated its Regulation ATS over the years to adjust to investor feedback and advances in technology. But if the order instead is routed to a wholesaler who has agreed to pay for it, the order is not going to an exchange, and is not necessarily receiving the benefit of broader competition. The wholesaler might sell to us at a price better than the best price shown to the public on the exchange but not necessarily the best price available.

This provides some insight into whether big block transactions are happening in an individual equity. A dark pool is a financial exchange or hub that is privately organized where trading of financial securities is held. Dark pools are in stark contrast to public financial exchange markets, where there is a high degree of regulation and media attention.

Can individual investors trade in the dark pool?

While the above scenario may work out well for the investment bank selling the shares, consider a retail investor who just purchased shares of the company the investment bank just sold 400,000 shares on a dark pool. Dark pools allow institutional investors to quietly find buyers and sellers for large orders without causing large swings in the market (typically against them). Dark pools were initially utilized mostly by institutional investors who did not want public exposure to the positions they were moving into, in case there were investors front running. Front running refers to an investor who enters a position into a security before a block trade is completed and can reap the benefits of the subsequent price movement.

The SEC maintains a registry of all operational alternative trading systems, which it updates monthly. To be an approved ATS, an operator must register as a broker-dealer and file initial operation reports, among other requirements. Another reason to fill large equity orders in dark pools is to obtain better pricing. It compares to trying to execute a huge trade on one exchange, where the price will have certainly decreased by the time the order is completely filled. With their growing popularity, regulators are concerned about issues related to market quality, price improvement, and market integrity. In 2018, the SEC adopted Rule 304 as an amendment to Regulation ATS to require the filing of Form ATS-N which includes a variety of disclosures about dark pools.

How do I see what portion of a stock’s trades take place in a dark pool?

Dark pools allow for trading execution away from the spotlight of public markets. Public markets tend to overreact or underreact due to news coverage and market sentiment. The pools facilitate trades that will trigger price overreaction or underreaction. Under FINRA’s transparency initiative, details of total shares traded each quarter by security in each ATS or dark pool are displayed on its website free of charge. Finally, and most controversially, dark pools can be used for routing transactions among wholesalers in payment-for-order-flow systems as described above. That’s not all the potential uses of dark pools, but those four cover a wide range of what dark pools can accomplish for their customers.

• Dark pools allow institutional investors to quietly find buyers and sellers for large orders without causing large swings in the market (typically against them).
• Since they can’t purchase these shares on the open market, the firm has to go onto a dark pool to make the purchase.
• One measure that may help exchanges reclaim market share from dark pools and other off-exchange venues could be a pilot proposal from the Securities and Exchange Commission (SEC) to introduce a trade-at rule.

With dark pools, large trades can be broken into smaller trades and executed before the price of a security becomes devalued. On the flip side, since there is no disclosure about large volume trading in dark pools, the shares that trade on the open market don’t necessarily reflect the demand and supply of shares accurately. Within a dark pool, however, the pension fund could try to sell all the shares they want to get rid of all at once (before the price can move against them). The fund could do this by matching with a buyer who agrees to the transaction price ahead of execution. This is as expected, given that a big feature of dark pools is that they allow institutions to trade in a more opaque setting away from the scrutiny of market participants that would try to front-run or otherwise game their trades. A dark pool is an alternative market where institutions can buy and sell stock with certain differences from trades on traditional public stock markets.

Independent dark pools

Some operate on a continuous trading basis throughout the day, while others are block trading-cross platforms. Some operate as non-displayed limit order books, while others execute orders at the exchange midpoint, and others that quickly accept or reject incoming orders. One of the top reasons why investors and traders use dark pools is to obtain better pricing by remaining private. Within a lit exchange, an institutional investor—such as a large pension fund—might try to sell thousands or millions of shares.

A pattern of multiple large trades with bullish characteristics has predicted very large bullish swings in the overall market, and the opposite pattern has predicted major downturns. Ian worked for Kerrisdale, a New York activist hedge fund, for three years, before moving to Latin America to pursue entrepreneurial opportunities there. His Ian’s Insider Corner service provides live chat, model portfolios, full access and updates to his “IMF” portfolio, along with a weekly newsletter which expands on these topics. The price with the most volume accumulated can signal the resistance level at which the ticker may consolidate and reverse down. The more volume that was transacted at that price, the stronger the support level is likely to be.

Why Do Dark Pools Exist?

Many private financial exchanges were established, and it facilitated traders who received very large orders and could not complete them on traditional public exchanges. Dark pools add to the efficiency of the market since there is additional liquidity for certain securities by getting them to list on the exchanges. Within these private platforms, suppose a trader wants to buy a stock at $100 per share for its client, but the lowest publicly posted bid price on the NYSE is a few cents higher per share. Instead of having to buy the shares for $100.05, for example, the broker could submit the order via a dark pool, hoping the private system has a match with another party willing to sell at that $100 price.

Since they can’t purchase these shares on the open market, the firm has to go onto a dark pool to make the purchase. Dark pool operators have also been accused of misusing their dark pool data to trade against their other customers or misrepresenting the pools to their clients. According toThe Wall Street Journal, securities regulators have collected more than $340 million from dark pool operators since 2011 to settle various legal allegations. Dark pools are sometimes cast in an unfavorable light but they serve a purpose by allowing large trades to proceed without affecting the wider market. However, their lack of transparency makes them vulnerable to potential conflicts of interest by their owners and predatory trading practices by some high-frequency traders.

Dark Pools and High-Frequency Trading

Instead, they’re meant for institutional investors who regularly place large orders for their clients. The purpose is to avoid affecting the market when these large block orders are placed. This allows them to make trades without having to explain their rationale as they look for buyers or sellers.