missing the boat on dark pools

Maybe it’s the name, as some have suggested, but for whatever reason electronic crossing networks for stock trading are being portrayed in the press as insidious devices that need a large dose of sunlight shone on them.

That’s not right.  Electronic crossing networks exist for a good reason  …two, actually.

why use a dark pool?

Suppose you’re the manager of the Fidelity Magellan Fund and want to sell your entire holding in Bank of America (BAC).  As of its end of May disclosure, that amounted to 25.2 million shares.

Here’s the plan:

–average daily trading volume for BAC on the exchanges is 60.6 million shares.  Let’s say you don’t want to be more than 10% of daily volume, so that your selling doesn’t disturb the market too much.  That means it will take you four days to trade out of the position.

That’s pretty straightforward.  The real trick is to keep your identity and intentions secret for as long as possible, so that news of your selling doesn’t reach potential buyers and cause them to lower their bids.  This may be doubly important if you have a reputation as a shrewd investor.  Worse still if you bought BAC at the bottom when others thought you were crazy: your selling may be taken as a strong sign that the party is over for that stock.  So the exit door may get pretty crowded if others find out what you’re doing.

call a broker?

In my experience, if you’re Fidelity, calling one of the big brokerage houses and placing a sell order, even for a small amount of stock, is not the best idea.  Within minutes, that broker’s proprietary trading desk will likely know about your order.  Shortly after that, so too will other brokers.  Everyone’s sales desks will then begin to call the trading arms of institutional clients, spreading the information.  After all, these guys make their money by generating lots of trading commissions, not by taking the best care of you.

…and lose outperformance?

In my view, good trading + the ability to keep your actions below Wall Street’s radar, can be worth 100 basis points in annual performance.  This is like gold in keeping your money management clients happy …and getting new ones.

try a crossing network

Preserving this treasure is why crossing networks were invented and why professional money managers want to do business through them.

the second reason

The SEC mandates that managers it supervises obtain the lowest possible trading cost.  That’s crossing networks.  In other words, all other things being equal, professional money managers (ex hedge funds) have a positive obligation to use them.

the Barclays case

Most investors don’t want high-speed traders in their crossing networks.  The latter’s computers can quickly detect unusual trading activity, which allows them to trade against this movement, both in and out of the dark pool.  Put another way, the element of secrecy, the key feature of the crossing network, is lost.

Barclays is accused, among other things, of running a dark pool whose largest participant was a high-speed trader while telling other participants no such damaging influence was present.


The big brokers are now saying the solution to the Barclays problem is to abolish dark pools.  Of course, I’m sure they’d also like to get rid of discount brokers and no-load funds as well.  But the real issue is alleged deceptive business practices by one of the big brokers themselves.  Eliminating alternatives to their trading desks is no solution.  If you’re not a borker, it’s crazy.






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