What is Anonymous Trading
Anonymous trading occurs when high profile investors execute trades that are visible in an order book but do not reveal their identity. Many stock exchanges, such as the London Stock Exchange, Toronto Stock Exchange, and NASDAQ, as well as dark pools offer anonymous trading. While most traders choose to trade non-anonymously, there are many reasons that larger traders prefer to keep their participation in a market a secret.
BREAKING DOWN Anonymous Trading
Anonymous trading is primarily used to avoid tipping off the market of a pending action, which could lead to front-running behavior, tracking of proprietary trading, or jockeying for the best position in an order book.
For instance, a large institutional buyer that's interested in acquiring millions of shares may not want to make their intentions known before they can complete the purchase. The risk is that smaller investors could bid up the price hoping to sell it to the institutional buyer for a quick arbitrage profit, or pennying could be used to unfairly gain execution priority.
Anonymous trading may occur through two different venues:
- Anonymous Exchanges - Many large stock exchanges started to offer anonymous trading when accessing the central order book due to competition from electronic communication networks (ECNs) that offer anonymous trading. Other stock exchanges offer hybrid trading systems that provide a choice of automated anonymous order execution and non-anonymous auction order execution.
- Dark Pools - Many ECNs offer anonymous trading through dark pools that operate outside of regulated national exchanges. Notably, these orders are only anonymous before and during execution rather than after execution.
Most anonymous trading is conducted by specialists and options market makers. Anonymous trades tend to be associated with a greater price impact, which suggests that those placing these orders are more informed than the average non-anonymous trader.
Benefits of Anonymous Trading
Anonymous trading can help reduce execution costs when used strategically to place orders, according to a 2011 paper in the Journal of Finance and Quantitative Analysis. In particular, anonymous orders have an average price impact that varied only between 10 and 12 basis points compared with 5 to 11 basis points for non-anonymous orders. That said, submitting a random order anonymously was not found to lower execution costs.
The best way to realize the benefits of anonymous trading is to take into account order characteristics, market conditions, and unobservable characteristics, such as information and investment strategy.
The downside of anonymous trading is that some parties tend to benefit more than others.