DEFINITION of ‘Dark Pool’
A dark pool is a private financial forum or exchange for trading securities.
BREAKING DOWN ‘Dark Pool’
Dark pools, a type of alternative trading system, give investors the opportunity to place orders and make trades without publicly telegraphing their intentions until the sale has been executed. They are mostly used by institutional investors for block trades involving a large number of securities.
The primary advantage of dark pool trading is that institutional investors making large trades don’t have to show their hand during the process of finding buyers and sellers. This prevents heavy price devaluation which would otherwise occur. If it was public knowledge, for example, that an investment bank was trying to move 500,000 shares of a security, the security would almost certainly have decreased in value by the time the bank found buyers for all of their shares. This has become an increasingly likely risk, with electronic trading platforms helping prices respond much more quickly to market pressures. If the new data is reported only after the trade has been executed, however, the news will have a much smaller impact on the market.
There are several different kinds of dark pools: broker or dealer-owned exchanges, like Morgan Stanley’s (MS) MS Pool and Goldman Sachs’ (GS) Sigma X; independently owned exchanges offering private trading to their clients; and private exchange markets operated by public exchanges, like the New York Stock Exchange’s Euronext. An privately-owned market will have price discovery within their own markets, but a dark pool operated by a broker or an existing derives its prices from public exchanges.
Because of their sinister name and lack of transparency, dark pools are often considered by the public to be very dubious enterprises. In reality, dark pools are tightly regulated by the SEC. However, there is a very real concern that because of the sheer volume of trades made on dark markets, the public values of certain securities are increasingly unreliable or inaccurate. There is also mounting concern that dark pool exchange provide excellent fodder for predatory high-frequency trading (HFT).