What is a dark pool?

31 May 2024

What is a dark pool?

A dark pool is a term to describe a private forum or marketplace where securities are traded. 

Dark pools operate outside of the public stock exchange, meaning that retail investors cannot trade on them and are generally unaware of their existence. It allows institutional investors to trade large volumes of securities without exposing their intentions to the wider market and also helps to keep the market under control. Only after the trades have been completed are the transactions in dark pools revealed, but this is not mandatory in all cases. 

Dark pools provide a solution to institutional investors potentially disrupting the market. In this article, we’ll be outlining what dark pools are, the different types of dark pools, as well as why they are considered controversial.

Dark pool definition

By definition, a dark pool is an exchange or financial forum which is used for trading securities privately, between institutions. The general definition is that they are not accessible by the public, and therefore trade under the radar.

Dark pools allow institutions to buy and sell large amounts of securities while staying anonymous, therefore not revealing their identity or their intentions to the public. The full size of their trades is also anonymous. After the transaction is complete, the trade details can be publicly disclosed, but are often not.

Although dark pools may seem less legitimate, they are still subject to regulatory oversight to prevent insider trading and market manipulation. Dark pools are primarily used by institutional investors, such as mutual funds, pension funds, and hedge funds.

History of dark pools

The first dark pool was created in 1979 and allowed any security on an exchange to be privately traded. By the late 1980s, dark pools were much more popular, and began to gain momentum, being referred to as ‘upstairs trading’.

It was not until 1998 that dark pools were properly regulated by the SEC. Today, dark pools are popular and make up a significant part of the market. According to Quantified Strategies, in 2022, dark pools accounted for 13.75% of the US equity volume and 7.5% of the total value traded in the European markets.

Types of Dark Pools

There are three main types of dark pools that are used.

▪️ Independent dark pools

▪️ Broker-dealer dark pools

▪️ Exchange owned dark pools

Independent dark pools are set up by independent companies to exchange privately. This can be at their discretion and opened to clients of their choosing.

Broker-dealer dark pools are dark pools where the clients of the broker trade, normally with other clients of the broker.

Exchange-owned dark pools are set up by public exchanges to allow for private trading. It means that clients can benefit from the anonymity and non-display of orders, and the exchange can benefit from keeping the trades steady.

What is dark pool liquidity?

Dark pool liquidity is the liquidity in these markets. It refers to the availability of buy and sell orders for securities in dark pools. Dark pool liquidity primarily consists of liquidity from institutional investors such as mutual funds, hedge funds, and pension funds. 

Being private, the liquidity is kept secret, and there are no market depth feeds or any other indication of the trades, until after the trades are completed.

Controversy surrounding dark pools

Dark pools have attracted controversy due to their anonymity and the fears that they encourage unfair and unsustainable trading. Financial inequality is increased as institutional investors have an unfair insight over the markets, and retail investors might not have the correct insight when looking at the market.

Both Barclays and Credit Suisse have been fined by the SEC for misleading investors about the operations of their dark pools and for failing to disclose certain information that affected trading decisions.

Dark pools are also associated with high-frequency trading (HFT) which are a source of controversy in themselves.

Are dark pool trades reported?

All trading for listed stock transactions in dark pools must be reported to the FINRA Trade Reporting Facility (TRF) and also must be published on the Consolidated Tape System, which is a system that serves to provide real-time data for stocks on an exchange.

Are dark pools legal?

Yes, dark pools are perfectly legal. While they might have an air of untrustworthiness, they are still legitimate. Dark pools are beneficial in providing liquidity to institutional investors while also keeping the markets steady. 

Furthermore, private and anonymous trading is legal, and is a fundamental aspect of trading laws, as it can prevent trading strategies from being stolen and helps to keep a relatively fair market. 

Using LiquidityFinder 

Finding the best liquidity provider can take some time, but at LiquidityFinder, we hope to provide a solution.

Research is required in order to find out the best liquidity provider for you, and as many different businesses have different requirements, you will need to find a liquidity provider that caters to your needs.

This is why we created our Match Matrix Service, which through a series of simple questions, will help you find the liquidity provider that is right for you. You will receive upon completion a personalised list of matching providers, and then with a few clicks be able to contact each one to get custom quotes and answers.

You can also post your liquidity request, and we’ll get back to you with custom quotes from verified providers.

You can also search FX, CFD and Crypto Liquidity Providers by specific instrument on our All Providers page. Add the symbol for the instrument you are looking for liquidity in, and the LPs that offer that instrument will be shown to you. In this example here, we are looking for those LPs that offer pricing in USD/KRW (Korean Won) but the same search can be made for any instrument or currency pair. 

You can also use this feature to look for which technology providers a Liquidity Provider uses and provides access to. 

This example shows which LPs are using the FX aggregator Integral for example. 

It takes just a few minutes to register with LiquidityFinder, and once you do, you’ll have immediate access to our exclusive network of liquidity providers, as well as gain access to tools such as our Match Matrix and our multi-provider request form. 

Stay up-to-date with our Insights too, where we update our audience on everything they need to know about liquidity, crypto and more.

Author

Caleb is a financial copywriter with a specialisation in fintech and forex. Former copywriter at Barclays and Paysafe. Contributing writer for LiquidityFinder. You can message Caleb here.