What is 'Dark Pool Liquidity'

Dark pool liquidity is the trading volume created by institutional orders executed on private exchanges and unavailable to the public. The bulk of dark pool liquidity is represented by block trades facilitated away from the central exchanges. It is also referred to as the "upstairs market," "dark liquidity" or "dark pool."

BREAKING DOWN 'Dark Pool Liquidity'

The dark pool gets its name because details of these trades are concealed from the public, clouding the transactions like murky water. Some traders who use a strategy based on liquidity feel that dark pool liquidity should be publicized to make trading more "fair" for all parties involved.

The Emergence of Dark Pools

With the advent of supercomputers capable of executing algorithmic-based programs over the course of just milliseconds, high-frequency trading (HFT) has come to dominate daily trading volume. HFT technology allows institutional traders to execute their orders of multi-million share blocks ahead of other investors, capitalizing on fractional upticks or downticks in share prices. When subsequent orders are executed, profits are instantly obtained by HFT traders who then close out their positions. This form of legal piracy can occur dozens of times a day, reaping huge gains for HFT traders.

Eventually, HFT became so pervasive it grew increasingly difficult to execute large trades through a single exchange. Because large HFT orders had to be spread among multiple exchanges, it alerted trading competitors who could then get in front of the order and snatch up the inventory, driving up share prices. All of this occurred within milliseconds of the initial order being placed.

To avoid the transparency of public exchanges and ensure liquidity for large block trades, several of the investment banks established private exchanges, which came to be known as dark pools. For traders with large orders who are unable to place them on the public exchanges, or want to avoid telegraphing their intent, dark pools provide a market of buyers and sellers with the liquidity to execute the trade. In 2016, there are more than 50 dark pools operating in the United States, run mostly by investment banks.

Dark Pools Under Scrutiny

Although considered legal, dark pools are able to operate with little transparency. Those who have denounced HFT as an unfair advantage over other investors have also condemned the lack of transparency in dark pools, which can hide conflicts of interest. The Securities and Exchange Commission (SEC) has stepped up its scrutiny of dark pools over complaints of illegal front-running that occurs when institutional traders place their order in front of a customer’s order to capitalize on the uptick in share prices. Advocates of dark pools insist they provide essential liquidity, allowing the markets to operate more efficiently.

RELATED TERMS
  1. Dark Pool

    A dark pool is a private financial forum or an exchange used ...
  2. Decentralized Dark Pool Trading ...

    Decentralized dark pool trading platforms are venues for anonymous ...
  3. Dark Web

    The dark web refers to encrypted online content that is not indexed ...
  4. Option Pool

    Stock in a startup set aside to be granted to employees is referred ...
  5. Commodity Pool

    A commodity pool is a private investment structure that combines ...
  6. High-Speed Data Feed

    A high-speed data feed transmits data such as price quotes and ...
Related Articles
  1. Insights

    An Introduction to Dark Pools

    Dark pools are an ominous-sounding term for private exchanges or forums for trading securities; unlike stock exchanges, dark pools are not accessible by the investing public.
  2. Investing

    Should You Wade Into The Dark Pools Of Liquidity?

    Dark pools of liquidity allow big investors to trade away from the public eye. They limit market impact but may leave small investors in the cold.
  3. Tech

    The Number Of Dark Pools In Cryptocurrency Trading Is Increasing

    Dark pools, which conduct trades away from cryptocurrency exchanges, are increasing in crypto trading.
  4. Personal Finance

    Dark Pools: The SEC Is Moving to Tighten Oversight

    The agency is concerned that dark pools' lack of transparency could disrupt the markets
  5. Insights

    What Is the Dark Net?

    The Dark Net (or Darknet) is a subset of secret websites that exist on an encrypted network.
  6. Trading

    You'd Better Know Your High-Frequency Trading Terminology

    The upsurge of investor interest in high-frequency trading (HFT) makes it important for industry professionals to come up to speed with HFT terminology.
  7. Trading

    Is Liquidity Improved By High Frequency Trading (HFT)?

    Is the market liquidity provided by high frequency trading a reality or an illusion?
  8. Trading

    Has High Frequency Trading Ruined The Stock Market For The Rest Of Us?

    HFT is a controversial trading strategy. This article looks at how HFT affects the retail investor.
  9. Investing

    Swimming Pools: Costs Vs. Long-Term Value

    Consider the costs of installing and maintaining a swimming pool, and compare this with the pool's utility and the market value it adds to your home.
  10. Trading

    Top Stocks High-Frequency Traders (HFTs) Pick

    High-frequency trading (HFT) firms make money by exploiting inefficiencies in the pricing of shares quoted on several exchanges in an increasingly fragmented marketplace. They also generate significant ...
RELATED FAQS
  1. What is liquidity risk?

    Learn how to distinguish between the two broad types of financial liquidity risk: funding liquidity risk and market liquidity ... Read Answer >>
Hot Definitions
  1. Bond

    A bond is a fixed income investment in which an investor loans money to an entity (corporate or governmental) that borrows ...
  2. Compound Annual Growth Rate - CAGR

    The Compound Annual Growth Rate (CAGR) is the mean annual growth rate of an investment over a specified period of time longer ...
  3. Net Present Value - NPV

    Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows ...
  4. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing a company that measures its current share price relative ...
  5. Internal Rate of Return - IRR

    Internal Rate of Return (IRR) is a metric used in capital budgeting to estimate the profitability of potential investments.
  6. Limit Order

    An order placed with a brokerage to buy or sell a set number of shares at a specified price or better.
Trading Center