Dark Pools

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Price formation
Impact on other market users
Possible market abuse


Turning from the venue of block order trades to a high-frequency trading spot of smaller and medium size orders, dark pools are now being questioned for their initial purpose and if their presence is lowering the market quality. Dark pool trading occurs when the client is submitting an order or a buy without stating his side, nor the size and price of the share. Therefore, he makes an anonymous bit or ask. The pre-trade information opacity leads to easier trading with less liquid stock and moderate prices. In general there are five types of ownership structures of dark pools. (UBB TechWeb, 2011) •Broker-dealers owned dark pools

Exchanges owned dark pools
Consortium owned dark pools
Independent dark pools
International dark pools
Overall, dark pool trading volume has been increasing steadily over the past decade. This is supported by technology innovations and changes in regulations stimulation competition. On the other side trading volume on ordinary exchanges had face a decline and reacted by creating their own dark pools and crossing networks. In December 2010 the trading in off-exchange venues reveals the highest-percentage of 13.3 per cent of the total volumes of all US exchanges. European markets have undergone a sharp rise in 2010, up to 4.18%. (See figure 1). Forecasts expect the US volume to reach 15 per cent at the end of this year, 8 per cent for the UK and 6 per cent for whole Europe. http://www.ft.com/cms/s/0/e52cbdc0-2fbd-11e0-91f8-00144feabdc0.html#axzz1F6JXCor9 http://www.marketwatch.com/story/dark-pools-account-for-4-of-europe-trades-study-2009-11-02 Motivation of market users (PWC 2008):

Non- displayed trading
Reduce market impact
Price improvement
Reduces transaction cost
High liquidity 
Maureen O´Hara (2003) considered price discovery as one of the main function of the security market. Demand and supply are supposed to balance and therefore preventing mispriced securities. However, dark pool orders are not displayed prior the transaction, and only in some cases after the trade, have a negative effect on the price discovery. Dark pools have created a two tier system of informed and uninformed traders. The withholding of the information results in a disequilibrium of the market prices. Therefore, the increase of dark pools is positively correlated with reduction of the effectiveness of price discovery. (Ye 2007) Presidential Address: Liquidity and Price Discovery The journal of Finance, vol. LVIII, no.4. aug 2005 Basic structures of dark pools:

Scheduled crossing networks (one single price of both sides is run simultaneously) •Indicated markets ( Clients can state their indication of interest ) •Continuous blind crossing networks (order book with limited hidden quotes)

Main pricing models of dark pools:
Derived pricing (average prices within a time frame)
Automatic pricing ( midpoint of the best bid and offer)
Negotiated pricing

Public Investors
Institutional investors, broker dealer and investors have turned to dark pools as electronic trading make best price matching simpler than hunting by someone own. Most dark pools are using continuous blind crossing networks, where the indications of interest (IOIs) of clients are shown. They contain valuable information about the trading interest and the best quoted prices within the non-transparent venue. Their purpose is to seek liquidity from other dark pools and to enhance executions at the original one. Therefore IOIs privileges the selected participants and this system disadvantages the uniformed public investor. (PWC 2010) Furthermore, post trade transparency is harmed since disclosed markets barely indicate the execution place of the trade and diminished the ability of the public the measure a stock’s liquidity....
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