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Dark Pool

Dark pool flow functionality is coming soon in 2023/2024


Dark pools are private trading venues designed to allow institutional investors to trade large quantities of securities without revealing their intentions to the broader market. The mechanics of how buy and sell orders are matched in dark pools can vary based on the specific rules and protocols of each dark pool. However, here's a general overview of how the process typically works:
  1. 1.
    Order Submission:
    • Participants submit their buy or sell orders to the dark pool. These orders include details like the quantity of the security they wish to buy or sell and the price at which they're willing to transact.
    • Unlike public exchanges, these orders are not displayed to other participants in the dark pool.
  2. 2.
    Matching Algorithms:
    • Dark pools use proprietary matching algorithms to pair buy and sell orders. The specifics of these algorithms can vary widely among different dark pools.
    • Some dark pools might prioritize matching orders at the midpoint of the National Best Bid and Offer (NBBO), ensuring that both parties get a fair price.
    • Others might use more complex algorithms that consider factors like order size, time, and other criteria.
  3. 3.
    Trade Execution:
    • Once a match is found, the trade is executed within the dark pool, and the securities change hands.
    • The details of the trade, such as the exact price and quantity, might be reported to a consolidated tape with a delay, and often without revealing the specific dark pool where the trade occurred.
  4. 4.
    Post-Trade Reporting:
    • Regulatory requirements dictate that dark pools report their trades. However, the level of detail and the timing can vary based on jurisdiction and specific regulations.
    • In the U.S., for example, dark pools are required to report trades to the Trade Reporting Facility (TRF) shortly after execution. However, the report might not reveal the specific venue or all details of the trade.
  5. 5.
    Protection Mechanisms:
    • Many dark pools have mechanisms in place to protect participants from predatory trading strategies. For instance, some dark pools might have minimum order sizes to ensure they're primarily used for block trades.
    • Some also employ anti-gaming algorithms to detect and prevent manipulative trading behaviors.

A hypothetical example to illustrate how dark pool order matching might work

Dark Pool: AlphaPool
  • Institution A wants to sell 1 million shares of Company XYZ.
  • Institution B wants to buy 750,000 shares of Company XYZ.
  • Institution C wants to buy 300,000 shares of Company XYZ.
  1. 1.
    Order Submission:
    • Institution A submits a sell order to AlphaPool for 1 million shares of Company XYZ at a minimum price of $50 per share.
    • Institution B submits a buy order for 750,000 shares of Company XYZ, willing to pay up to $51 per share.
    • Institution C submits a buy order for 300,000 shares of Company XYZ, willing to pay up to $50.50 per share.
  2. 2.
    Matching Algorithm in Action:
    • AlphaPool's algorithm first identifies that Institution A's sell order and Institution B's buy order can be matched since the price range overlaps.
    • The algorithm matches 750,000 shares of Institution A's sell order with Institution B's buy order at a midpoint price of $50.50 (a price beneficial to both parties).
    • Now, Institution A still has 250,000 shares left to sell.
    • The algorithm then matches the remaining 250,000 shares of Institution A's sell order with Institution C's buy order at the price of $50.50.
    • After these matches, Institution A's entire sell order has been fulfilled. Institution B has acquired all the shares they wanted, but Institution C only managed to buy 250,000 out of the 300,000 shares they wanted.
  3. 3.
    Trade Execution:
    • The trades are executed within AlphaPool. Institution A sells a total of 1 million shares: 750,000 to Institution B and 250,000 to Institution C. All trades are executed at $50.50 per share.
  4. 4.
    Post-Trade Reporting:
    • AlphaPool reports the trades to the relevant regulatory body, indicating that 1 million shares of Company XYZ traded at $50.50. However, the specific details about the participants and the exact venue might not be disclosed.

Why is it possible to tell whether the order execution is bought or sold from the tape?

In the example provided, the consolidated tape (or public reporting mechanism) would typically show an aggregated view of the trades without revealing the specific participants or the exact venue (i.e., which dark pool).
For the trades in AlphaPool:
  1. 1.
    A trade of 750,000 shares of Company XYZ at $50.50.
  2. 2.
    A subsequent trade of 250,000 shares of Company XYZ at $50.50.
These would be reported as two separate trades on the consolidated tape. The tape would show the security (Company XYZ), the number of shares, and the price ($50.50), but it would not typically indicate that the trades occurred in AlphaPool or identify Institutions A, B, or C.
It's worth noting that there are many different dark pools, each with its own set of rules, protocols, and priorities. While they all operate on the principle of providing a venue for discreet trading, the specifics of how they match and execute orders can vary widely.