What is 'Dark Pool Liquidity'

Dark pool liquidity is the trading volume created by institutional orders executed on private exchanges and which are mostly 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 until after they are executed, 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 multimillion-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 that 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 were 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. High-Frequency Trading - HFT

    High-frequency trading - HFT is a program trading platform that ...
  3. Whole Pool

    A whole pool is an undivided interest in a group of mortgages ...
  4. Commodity Pool

    A commodity pool is a private investment structure that combines ...
  5. Multinational Pooling

    Multinational pooling is a method global companies use to manage ...
  6. Fourth Market

    The fourth market is a market that trades securities on a private, ...
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. Insights

    What Is the Dark Net?

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

    Is Liquidity Improved By High Frequency Trading (HFT)?

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

    How to Choose a Cryptocurrency Mining Pool

    Here are some selection criteria cryptocurrency miners should consider before joining a crypto mining pool.
  6. Trading

    Strategies And Secrets Of High Frequency Trading (HFT) Firms

    Secrecy, strategy and speed are the words that best define high-frequency trading (HFT) firms.
  7. 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.
  8. Tech

    How Do Cryptocurrency Mining Pools Work?

    Here's how cryptocurrency mining pools work.
  9. Insights

    Hedge Funds and the Law

    Learn how hedge funds have gotten in trouble for illegal insider trading. Read about questionable high-frequency trading (HFT) strategies.
  10. Trading

    High-Frequency Trading: A Primer

    An in depth look at how high-frequency trading works and who the players are.
RELATED FAQS
  1. Why is the Dark Cloud Cover pattern important for traders?

    Learn the significance for traders of the dark cloud cover candlestick pattern, a bearish indicator closely related to the ... Read Answer >>
  2. What is high-frequency trading?

    High-frequency trading is an automated trading platform that utilizes powerful computers to transact a large number of orders ... Read Answer >>
  3. What is liquidity management?

    Take a look at the different definitions of liquidity, and find out how investors and businesses attempt to reduce exposure ... Read Answer >>
  4. 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 >>
Trading Center