How to Trade Dark Pools in Day Trading

The stock market is basically a venue where traders and investors meet to buy and sell shares and other types of assets. In the United States, brokers provide their investors a lot of information that help them understand the order flows and movements of key assets.

We have covered briefly about this information when we looked at level 2 and time and sales (reading the tape) concepts.

In this report, we will look at another relatively unknown concept known as dark pools and how you can use it in the market.

What is a dark pool?

A dark pool is an alternative trading system (ATS) that allows large buyers and sellers to execute orders without moving the market significantly. Dark pools solve the problem by hiding these transactions from the overall market.

In the public markets like the New York Stock Exchange (NYSE) and Nasdaq, such transactions are usually recorded and can have significant impacts on the market.

For example, if an influential institutional investor like Warren Buffett is buying shares in a company, the stock could jump sharply. However, with dark pools, this information is hidden, which prevents this volatility.

The concept of dark pools has been around for decades. It started in the 1980s, which forced the Securities and Exchange Commission (SEC) to study and analyse it. The commission started creating rules to guide the industry in the 1980s. And in 2010, it published a paper on equity market structure, which expressed concerns on these pools.

Today, all dark pools in the US are registered by the SEC. Also, in 2014, the Financial Industry Regulatory Authority (FINRA) made new rules to make some information in dark pools public to traders.

Different types of dark pools

There are three primary types of dark pools in the market.

Independent

An independent dark pool is provided by individual companies. These companies must register with the regulators such as SEC and FINRA. They are known to offer low transaction costs and solve issues associated with low liquidity.

Some of the most popular independent dark pools are owned by Instinet, which is owned by Nomura, and Smartpool, which is owned by HSBC, JP Morgan, and BNP Paribas.

Broker-dealer owned

A broker-dealer is a company that buys and sells stocks for its accounts and for clients. These darkpools are known for offering price improvements through the National Best Bid and Offer (NBBO).

Some of the broker-dealer owned dark pools are offered by Barclays and Credit Suisse.

Exchange-owned

These dark pools are owned by exchanges like the NYSE, Nasdaq, and BATS. These dark pools are mostly used by high-frequency traders and usually tend to provide liquidity to the market.

Benefits of dark pools

Dark pools offer advantages, mostly to the institutional investors who benefit with the fact that their trading information is not public. As such, the investor is buying blocks of shares, is able to keep their information private and thus buy at a good price.

Also, these buyers are able to keep their transactions anonymous. In addition, among the dark pool providers, there is also excellent trade execution. Finally, there is the benefit of using this data in high-frequency trading.

Dark Pool Index

DTTW™ offers its partners some dark pool indices for day trading.

Final thoughts

Dark pool is an alternative trading system that is offered by independent companies, broker-dealers, and investment companies. They help large investors and small market participants get involved in the market anonymously. They are also essential tools used by high-frequency traders.

However, for beginner traders, dark pools are relatively difficult concepts that are relatively impossible to execute. For one, they are not offered by many brokers they use.

External useful Resources

  • 10 Things You Need to Know about Dark Pools – dummies
  • Dark Pool Trading System & Regulation – CFA institute

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