What is Dark Pool trading?
Dark pools are a type of alternative trading system (ATS) for non-exchange trading that is continuously growing. The ability to trade Dark Pools was created so that high capital/institutional buyers and sellers could trade large blocks of shares without causing the market to react against them. By allowing these large traders to execute these trades off the exchange, large price swings and market dislocation are avoided.
What is the purpose of a Dark Pool?
A Dark Pool allows institutional investors to execute a large size trade while avoiding potential downward pressure caused by other investors. In a traditional exchange/market structure, this individual would have to execute this large trade over many small trades leaving open the possibility for price to change in-between the many small trades placed. Dark Pool trades can avoid this price dislocation in-between orders because order books are non-existent in these alternative trading systems. The Dark Pools allow institutional traders to execute trades with much larger sizes allowing them to receive better-priced purchases and sales than they would in a traditional market structure.
What does this mean for market structure?
Investments made in the Dark Pools are not reported until 24 hours later, meaning that nobody but the individuals who placed the trades are aware of the trades that were placed in the alternative trading systems. In its simplest form, a market is just supply and demand, since these trades are not visible in the current day it means that the price of a security might not be an accurate depiction of the supply and demand for that security because millions of dollars could have been invested in these alternative trading systems that will not be available until the next day. Dark Pools affect price discovery and can cause price dislocation, that is why they are so important.
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