There have been lots of whispers about traders using DARK POOLS to make unbelievable profits in the stock exchange. But what are those mysterious pools that have got nothing to do with swimming? And is it possible for every one of us to use them to gain great fortunes?
Dark pools have been around since the late 1980’s so they are not a new invention. They are the gloomy nonpublic market places of investing. The spread is the price difference between the bid and the offer in stock exchange. In Dark pool the price is always matched in the middle. This means that the price is set just in between of the bid and the offer prices. The purpose of the Dark pool is the get a bit better price both for the buyer and the seller. Closing deals in pools is cheaper because there aren’t any trade fees that investors normally pay in open markets.
Dark pools are usually owned by a bank or broker because it is much more cost effective to match a trade in a dark pool than in the stock exchange. Owners will probably try to find buyers/ sellers from their own dark pools before even putting the bid or offer to the open stock market.
The use of dark pools happens through stock brokers. When a small investor places a bid or an offer there is the possibility of the transaction going through a dark pool or multiple dark pools instead of going straight to lit market. Stock brokers don’t have to tell their clients about the route if the client doesn’t ask about it.
Dark pools and HFT ( High frequency trading) programs are available to only limited users. Private investors are not able to use them because of the complexity of the programs. Dark pools aren’t accessible to small investors so the only way to make trades in dark pools is to make the deals through stock brokers or dealers who have an access to them.
Every closed deal that takes place in those secret market spots is usually made by high speed computer programs. High frequency trading is limited to investors who really know what they are doing. The growth of power in computers and in speed of data transfers has made the use of dark pools and HFT programs more common.
High frequency trading (HFT) in a nut shell
HFT means very complex algorithmic programs that need powerful computers to transact a large number of orders in just a few milliseconds to make deals in stock markets. Colocation of the servers is important because price changes must take place in speed of light. The traders with the fastest execution speeds will be more profitable than traders with slower execution speeds.
HFT programs manipulate prices by changing prices to meet the needs of an HFT users. For example If HFT user has a large amount of stocks to sell and the mid-price of bid and offer needs to be increased the program will bid on a small number of the same stock in public market, the price will rise because darks pools always work on a mid-price. After selling the number of the stock needed the HFT program withdraws the bid. The whole thing happens in just a few milliseconds. The profits of HFT traders have come down since more and more competitors have competed about the same profits.
For the trader the best and almost the only way to keep up with the fast changes is to know what you are doing and read everything there is about the Dark pools and HFT’s. Understanding is the key element in being even a half a step ahead when machines start to trade. So sadly not everyone can be a dark pool user and the complexity of the programs narrows down even more the number of potential HFT players.