Dark Pools

Dark pools are one of the current buzzwords on Wall Street today. A dark pool is a crossing network that provides liquidity that is not displayed on exchange order books. Dark Pools are designed to allow traders to move large numbers of shares without other traders knowing what they are doing.

As trading volume increasingly flows to the dark pools, concerns have been expressed. How much volume is being traded in dark pools? How is this affecting transparency and liquidity on the exchanges? Will dark pools make price discovery harder in the future?

Dark pools have tremendous advantages for large traders. Simply put, it costs less for a trader to execute a large block of stock in a dark pool than it does to execute the same block on an exchange[1]. If a trader is looking to buy 100,000 shares of stock on an exchange, word will quickly leak out to other traders who will pull their offers to sell in the hopes that the larger trader’s buy order will drive up the price of the stock. Orders sent to a dark pool are anonymous and large traders can quickly move their orders without having the price rise significantly.

“Dark” trades are now estimated to be 10 – 12 percent of all stock trades[2]. Measuring the volume executed in dark pools seems like a straightforward exercise, but is not. Some pools are linked to other pools electronically. If an order for 500,000 shares is sent to Pool A perhaps 400,000 will be executed there. Pool A will then send the remaining 100,000 shares to Pool B for execution. Pool B will report that they executed 100,000 shares. Pool A might report that they executed 500,000 shares since they did 400,000 themselves and arranged for the execution of the remaining 100,000. So the reported volume is 600,000 instead of the 500,000 that was actually transacted. Bids chief executive Tim Mahoney says, “The issue is that exchanges clearly single-count [volume] while almost everyone away from them double-counts.[3]” Goldman Sachs has just announced, in June 2009, that they will begin reporting volume on Sigma X (their dark pool) on only one side of the trade[4]

Some industry insiders are concerned that dark pools may make it difficult to clearly price a given stock. In the past, the price of IBM on the New York Stock Exchange was certain to be the best available price. As more volume flows away from the exchanges, will the exchanges really have the best price? Time will tell on this one.

Exchanges are concerned about pools from a competition standpoint. As more volume flows to the pools, the revenue exchanges realize from the fees they charge member firms will drop. To counter this, some exchanges are starting their own dark pools. As of July,
2008, the NASDAQ was executing about 18% of its volume through its “non-displayed platforms” and NYSE Euronext plans on connecting to a number of existing Dark Pools[5].

Give the current political environment, it would seem to be only a matter of time before regulators begin looking at dark pools. Concerns will no doubt be raised that these off exchange markets lock out the small trader, reduce liquidity and call into question the accuracy of “public pricing”. Erik Sirri, the SEC’s director of market regulation, said in a speech in February of 2008 that access to dark pools could raise “serious concerns about two-tiered markets” that might hurt small investors[6]. Mr. Sirri went on to say that dark pools “threaten to supplant quoting venues and cause the equity markets to become less transparent.”

On May 19, 2009 James Brigagliano (co-acting director of the Division of Trading and Markets of the SEC) stated that dark pools could adversely affect execution quality, decrease liquidity and “harm price discovery and worsen short-term volatility”[7].

Additionally, Thomas Callahan, an executive vice-president at NYSE Euronext, has asked Congress to pressure the SEC to look at regulating dark pools[8]. The request came during his testimony before the House Financial Services Committee. He asked that “Alternative Trading Systems” be subject to the same regulations that exchanges are.

Stayed tuned for this fight, it should be the next big regulatory dust-up between the government and the securities industry.


[1] Traders Magazine.com, “ITG Study Fuels Debate on Dark Pool Trading Costs”, www.tradersmagazine.com/news/102051-1.html, May 6, 2009.

[2] Emily Chasan, “Dark Pools May Obscure Market Prices”, www.Reuters.com, April 21, 2008.

[3] Financial News, “Clarity Needed on Dark Pool Volumes”, June 9, 2008.

[4] TradersMagazine.com “Inching Toward Dark Pool Reporting Standards”, June 26, 2009


[5] Fitzgerald, Keith, “Are Dark Pools Destined to be the Capital Markets’ Next Black Hole?”, www.moneymorning.com/2008/07/10/dark-pools.

[6] Sirri, Erik R. Keynote Speech at the SIFMA 2008 Dark Pools Symposium, www.sec.gov/news/speech/2008/spch020108ers.htm.

[7] Mehta, Nina, “Top SEC Trading Chief Takes Aim at Dark Pools”, http://www.tradersmagazine.com/news/-103787-1.html?ET=tradersmagazine_news:e302:54638a:&st=email

[8] Chapman, Peter, “NYSE Euronext Asks Congress to Press the SEC on Dark Pools, Traders Magazine, www.tradersmagazine.com/news/nyse-euronext-dark-pool-regulation-sec-103871-1.html?ET=tradersmagazine_news:e32