Dark Markets

“Darkness” refers to a lack of pre-trade quote transparency - neither the buyer nor the seller posts a visible bid or ask (Hasbrouck, 2017). Dark pools are alternative trading systems in which dark trades of securities and other financial instruments take place; these marketplaces are frequently used by large block traders (such as exchanges and institutional investors) who wish to trade without revealing information pre-trade that may cause markets to move against them (Aguilar 2015). Dark markets function in contrast to ‘lit’ markets; in lit markets, pre-trade bid and ask quotes are publicly displayed. Examples of lit markets include national exchanges, such as the New York Stock Exchange and the Nasdaq, and other traditional pools of liquidity.

References

1. Aguilar, L. (2015, November 18). Shedding Light on Dark Pools. Retrieved on August 17, 2020 from https://www.sec.gov/news/statement/shedding-light-on-dark-pools.html
2. Hasbrouck, J. (2017, June 21). Securities Trading: Principles and Procedures. Chapter 8: Dark Markets. Retrieved on August 31, 2020 from http://people.stern.nyu.edu/jhasbrou/TeachingMaterials/STPPms12a.pdf

Recommended Readings

As you read through the articles below, think about the distinguishing features of dark pools and why they have been reported as a “haven for predatory high-frequency traders.”

1. Shedding Light on Dark Pools

Aguilar, L. (2015, November 18). Shedding Light on Dark Pools. Retrieved on August 17, 2020 from https://www.sec.gov/news/statement/shedding-light-on-dark-pools.html 2.

Chapter 8: Dark Markets (pages 62-66)

Hasbrouck, J. (2017, June 21). Securities Trading: Principles and Procedures. Retrieved on August 17, 2020 from http://people.stern.nyu.edu/jhasbrou/TeachingMaterials/STPPms12a.pdf

Check Your Understanding

Question 1

Which three of the following six features/statements are associated with dark markets? Which three are associated with lit markets?

1. In this type of market, buyers and sellers post visible bids and asks.
2. Attracting sufficient liquidity has often been a problem in this type of market.
3. The New York Stock Exchange is an example of this type of market.
4. The prices established in this type of market are often relied upon by the other type.
5. Participants in these markets often lack crucial information about how their trading systems function—and about the serious conflicts of interest they can harbor.
6. In this type of market, market impact is significantly reduced for large orders.

Question 2

Q2: You are participating in the market as an individual, slow investor (you are not supported by the sophisticated trading technology used by high-frequency trading firms). Would you prefer to participate in:

1. A dark market or a lit market? Why?
2. In a market with speed bumps or without speed bumps? Why?

Question 3

In your own words, explain why dark pools have been reported as a “haven for predatory high-frequency traders”.