A Guide To Dark Pool Trading And How It Effects Small Investors
If you’ve been paying attention to stocks like GameStop ($GME), AMC Theaters ($AMC), and others. you may have witness sudden drops in prices by 30% or more.
The reason this happens is due to a type of trading called Dark Pools.
In this article will discuss about:
- What is Dark Pool trading?
- Do Dark Pool trades get reported?
- Can Dark Pool trading harm a price
- Is Dark Pool trading legal?
Ok, let’s get started!
What is Dark Pool Trading?
Dark Pools are used to conduct large transactions (think of 100,000 or more shares) from one institutional investor to another. These type of large transaction are also known as block trades.
Institutional investors use this alternative trading method for multiple reasons including but not limited to:
- Limiting their exposure from other investors being institutional or retail.
- Obtaining better pricing for their trades
- Paying much lower fees since these forums are mostly hosted by an institutional investor
- Preventing the devaluation of a stock while they find a buyer due to public speculation or competing institutional investors
In simple words, Dark Pools are used to hide trades until they are executed and reported to CTA (Consolidated Tape Association).
Do Dark Pool Trades get reported?
Yes, but with heavy delays. While this data can now be had for free courtesy of FINRA, it is updated on a weekly basis.
Large institutional investors get access to this data real time through their own infrastructure called securities information processors also known as SIPs.
Can Dark Pool trading harm the price of a stock?
In short Yes. Due to the restricted access and the lack of transparency, dark pool trading puts you, retail investors, at several disadvantages. The biggest probably being price differences.
For example, let’s say hedge fund A and hedge fund B are liquidating their position on stock “X”.
If done on the open market this would generate a massive spike in selling pressure on stock X driving the price down.
You, as a savvy investor might spot the change in price action and the downward trend and might decide to buy the dip.
However a trade done on a dark pool wont immediately show on the market as it has to be reported to the CTA (Consolidated Tape Association) first.
So you might still want to buy stock X because you think it’s a great value. But since the selloff has not been reported at the time that you’re buying, you might be paying $100 per share of stock X while the stock at the time of you buying it might be worth $80.
So in the end you ended up overpaying $20 per share because you aren’t being given the same access and tools as institutional investors.
Is Dark Pool trading legal?
Yes, even with their lack of transparency and being prone to conflicts of interest dark pools are a legal alternative Trading System (ATS).
Thankfully, the SEC is paying close attention to dark pools due to accusations of unfair trading practices like front-running (institutional traders place their order in front of a customer’s order to capitalize on the uptick in share prices).
In summary, dark pools will continue to be a controversial and hotly debated topic in the future. While they have perceived pros and cons they are truly a double edge sword for retail investors. When used as originally intended they can shield stock prices from unnecessary volatility and fluctuation. When used improperly they can be used to manipulate stock prices and hide conflicts of interest.
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