Dark Pools – The newest avenue for equity trading volumes

Dark pools (or Dark liquidity pools or dark liquidity) have generated a great deal of buzz off late. The name sounds esoteric and generates curiosity on hearing it. They emerged as a result of the need to reduce the obvious information leakages which happened when large  institutional investors traded large quantities of securities on the traditional primary exchanges.

Dark pools solved this problem to an extent. Dark Pools essentially represent that trading volume / liquidity which is only available only to a select few investors and not to the general public. Traditional exchanges are transparent with regards to disclosure of limit orders in the system and follow the system of a limit order book whereby competition between buy and sell orders result in a trade. Dark Pools on the other hand concealed this pre – trade transparency from the general public, thus clouding the transactions like murky water and hence the name dark pool.

The US Equity markets today are a vast, decentralized electronic network whereby there are competing avenues where trading volumes happen. Unlike here, where NSE dominates the market, US market is a different ball game altogether.

Equity trading volumes in the US have shifted away from the primary markets to newer trading venues which are off exchange venues trading avenues. The market share of almost all exchanges has been trending downwards while off-exchange volume increases.

Off – exchange business can be broadly categorized into transactions that occur on;

  • Alternative trading systems (ATS).
  • Electronic communications networks (ECNs) and
  • Dark pools (undisplayed liquidity pools);
  • OTC transactions.
  • Equity Market Structure – US


  • Regular exchanges are;
  • –      Structured as Electronic limit order book (LOB) markets (ORDER MATCHING; PRICE – TIME PRIORITY)

    –      Multilateral with multiple buyers and sellers,

    –      Nondiscriminatory  in terms of access, and

    –      Pre-trade and post-trade transparent: Prices and trading interest are displayed prior to execution, and transaction details are publicly disseminated in real time.

    –      The role of brokers in limit order book markets is limited to facilitating the execution of client orders.

  • A common aspect off – exchange transactions (i.e. ATS & OTC) is the absence of pre-trade transparency. Orders are not publicly displayed prior to execution.
  • History of Dark Pools – Can be traced to the mid – eighties

  • In 1986, a company known as Instinet started an After Hours Cross, whereby clients entered orders into a call auction. At 6:30 pm (local time), an algorithm would be run to match buyers and sellers using that day’s closing price for all trades and print the resulting trades on a third market printing facility.
  • Unmatched trades went unfilled and data on these unfilled orders were not disclosed, to avoid influencing exchange prices by giving clues about outstanding demand.
  • The match allowed large buyers and sellers to transact without pre-trade transparency and potential information leakage. This was the first dark pool.
  • Types of Dark Pools

  • Independent Company operated Dark Pools (For eg. Instinet)
  • Broker operated Dark Pools (For eg. Citi’s  – Citi Match, Credit Suisse – CrossFinder)
  • Public exchange operated Dark Pools (For eg. NYSE Euronext operated)
  • Consotium Sponsered Dark Pools
  • Benefits of Dark Pools

    Lack of pre – trade transparency and lower impact costs resulted in increased anonymity and lower transaction costs which is what every institutional investor dreams of.

    The above benefits combined with new technologies like SOR’s (Smart Order Routers; trading engines that smartly searched for the best market for executing a trade based on set parameters) and Broker dealer internalization (pvt. trading network of brokers to internally match client orders and saving on exchange fees) led to explosive growth of Dark Pools.

    Therefore what started off with Instinet’s After Hours Cross, which was a call auction only at the end of a trading day led to ITG’s Posit which periodically crossed trades during the day and subsequently Posit Now, which continuously matched trades.

     Example of Broker SOR execution:

    Suppose a broker gets an order of 1,00,000 shares of company A. The broker algorithm would retain the customer order within the in – house dark pool awaiting for oppurtunities to be matched with other customer orders. Simultaneously it would split the order into smaller orders and route them to primary exchanges and certain off – exchange market places. If the order is partially filled in – house then it instantly re – sizes the total order and orders submitted to other markets. Thus, SOR’s have become the key to success in dark pool trading.

    Market Share of different trading venues – US

    Trading Venue % Share
    On – exchange 67%

    Primary Exchanges

    Off Exchange 33%







    Dark Pools



    Concluding Remarks

    Institutional investors faced problems of information leakage when trading in large quantum of securities on traditional exchanges with respect to confidentiality as also high impact costs. Dark pools allowed them to overcome the shortcomings while trading large sized orders.

    Some of the concerns;

    –      Fall in transparency,

    –      Distortion of competition and fairness due to uneven playing field between different types of trading venues and different classes of investors

    –      Limit orders—the building blocks of price discovery— could be potentially harmed if a significant proportion of orders are filled off-exchange at the expense of the limit order submitter.

    Indian equity market infrastructure is dominated by the NSE. However, with the benchmark indices stuck in a range for the past so many years there isn’t great deal of interest in the equity markets. As a result, equity trading volumes in the spot market have been stagnant at ~ Rs 10000 Cr. If the market picks up, one might very well see the entry of such alternate trading avenues providing an alternative to investors and the entrenched incumbents a run for their money.


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