What are Dark Pools?
A dark pool is a system in which investor can trade their security privately without getting anyone to know about the trade. With the introduction of the online trading system, the dark pool came into existence. In the year 1979 dark pools came into origin in the U.S. and the exchange of security was allowed to take place privately. Previously a dark pool was known as Upstairs Trading and from 1980 investors started trading under dark pools. By the time of 1986 dark pools become much popular and many investors started trading under them. Till 1998 this service was not regulated by the Security Exchange Commission but as and when the user of this service started increasing by investor from 1998 Security Exchange Commission regulate them. It was also observed that by 2007 average of 40% of trading was taken place in Dark Pools.
Get complete CFA Online Course by experts Click Here
How does it work?
Dark Pool is simply a trading place where investors can trade their security in bulk and also privately. This helps investors to keep their identity hidden and there is no sudden change in the price of a share if investors sell or purchase a sudden amount of share at a time. If dark pools don’t exist and some known investor or particular institution decides to sell the amount of his share and this information gets available in public then the price of a particular share may fall drastically and the same happened in the opposite situation if an investor tries to purchase some share then the price of that particular share may rise within a second. Thus, a dark pool was introduced for such kind of institutional investor to control the price fluctuation in the market, and in the current situation, most of the investor whether they buy or sell a small or large amount of share is trading in dark pools.
- Independent: Under independent dark pools, various independent operators and companies operate individually in this service. Often the fees and transaction cost is low in independent dark pools as compare to other service providers.
- Broker-Dealer Based: Broker-Dealer Based dark pools are run by various investment banks and such institutions. Under this type, the client of various brokers from a type of dark pools service interacts with each other for placing an order and the identity of this client is been kept hidden.
- Exchange Based: The use of dark pools for trade purposes is been increasing day by day thus various public exchanges provide this service specially to the small traders but the cost of fees and transaction is high in this type of dark pools.
- The biggest advantage of the dark pools service is that various institutional investors can trade this security privately without getting anyone to know about it. This help to stabilize the price fluctuation in the market if a huge number of shares had been traded publically.
- They help to maintain market efficiency because the common public will start panicking if a little bit of news comes in the market for the trade of specific types of security.
- With the help of it, investors can trade large amounts of shares at fixed times according to the need of traders.
Get complete FRM Online Course by experts Click Here
- The biggest disadvantage of dark pools is speculation. Various companies try to speculate this share by buying and selling large amounts of shares at a particular point in time.
- They create a lack of transparency which results in unfair advantage to various speculators in the market and can harm the common motive of the public.
- Before the dark pool was regulated various unfair advantages were taken by various investors to gain short-term high profit on its company’s share.
A dark pool is an integrated part of an exchange market for any country but despite having various advantages dark pool can heavily impact the motive of the common public in the country. Nowadays there are various investors whether it be big companies or individuals trade under dark pools. On the one side, it also helps the market to work efficiently and on the other side, there are various drawbacks for the same. But if dark pools don’t exist then slit change in the purchase and sale of a particular share can create a big movement in the market.
Author: Charmi Mehta
About the Author: Charmi Mehta is currently pursuing MBA with a specialization in Finance from the Department of Business Administration, Bhavnagar. Charmi is very much interested to work with data and its analysis and she is also fascinated by the financial market.