A Dark pool is an alternate trading method or system that facilitates the buying and selling of a considerable number of shares of a company without having to suffer detrimental price movement or disrupting normal trading. Dark pool trading is suited for shares that are decidedly liquid and with low volatility. These pools are usually not feasible to the general public. They are called dark because nobody knows the size and price of the orders.
How do dark pools work?
Usually, when a large number of shares, say a million shares of a reputable company are sold, it leads to falling in share prices and the last million shares to be sold will not receive the same price as the first million. Dark pools overcome this drawback by completing the entire exchange at a fixed price. These transactions are anonymous and there is no data available pre-trade.
Risks in dark pool
Two noticeable risks associated with dark pools are:
- Price movement: An unfilled order augments submission to an exchange for executing the transaction. Invariably there will be significant price difference, which most often works against the investor, between the time taken to submit the dark pool and execute it in exchange
- The risk of information leakage. There is a constant threat of dark pool operators shorting the concerned company to make a decent profit. That is why you must choose a dark-pool operator of repute.
Types of dark pools
There are several dark pools which can be segregated into three types.
- Broker-dealer owned: Goldman Sachs and Credit Suisse are few names associated with broker -dealer owned dark pools. When the buyer and the seller of share are clients of the same broker, to avoid paying two transaction fees to any extraneous dark pool, the broker and dealers set up their own dark pools and share the savings with the clients.
- Exchange owned: NYSE and Euronext are two examples of exchange owned dark pools which offer retail traders greater liquidity and more high-frequency trading practices.
- Independent operators: As the name suggests, these dark pools are owned by independent companies that offer low transaction rates alongside low liquidity. ITG and Smartpool are independent operators. There is no price discovery in this case just like in broker-dealer owned dark pools.
The Bottom Line
To a novice, the Fincrowd app is one aspect of trading while dark pools are a highly regulated method of trading usually indulged in only by professional traders. The absence of transparency in dark pools leads to disputes between the owners and the trading practices. But a significant amount of daily trading takes place via dark pools.