Trade Ideas Blog

Dark Pools Looking More Like the Kiddie Pool: Shallow and Smelly

May 9, 2008

2 interesting articles this week from WSJ and Reuters on the untamed and unaccountable dark pools in the market.

What are dark pools?

The WSJ defines them as “the secretive electronic trading networks that match buyers and sellers anonymously.” These trades are done outside of the traditional stock markets like the NYSE and NASDAQ.

The WSJ journal points to the dark pools at failing on their promise of making it easy to move large shares without affecting price. In fact with more dark pool firms competing for volume and their share of the business, the consulting firm TowerGroup reports that the average trade was just 260 shares at the beginning of 2008. A decade ago it averaged over 1,400 shares. Ugly shrinkage.

The Reuters article observes that as a result of the competition for liquidity and volume, many dark pool firms are falsely boosting their trade volume numbers. With no standards among these market players, many are knowingly double counting attempts to fill blocks as new and reportable volume.

I mention the articles because this has been a recurring theme when I speak with our Director of Trader Education, Jamie Hodge. He shared his observations in his recent interview with StockTickr:

StockTickr: How do you think the market has changed over the last several years? How have you adapted?

Jamie: The biggest issue has been the systematic retooling of the trading network over the past 7 years. In 96 when I first started trading there were 0 ECNS, it was just all market maker’s thick bids and offers and you could see exactly who you were trading against. It’s quite the opposite today, no liquidity and you can’t see anything. Take all of your ecn books, level II, and any other feed you can pay good money for and you’re lucky if you’re seeing 10% of the real order flow. Just like casinos have banned card counting at black jack the big boys have taken every advantage away from the small day trader. Now more than ever, you need to fight algorithms with algorithms.

Our point? The larger market participants play their games at the expense of those not armed with better or equalizing technology and analytics. They prey on the regular investor/trader unequipped to react. The technology is here. It’s available to our subscribers and traders who recognize they need real-time analytics. Whether you use Trade-Ideas or not, it’s time to make software work for you and your trading plan.