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The Importance Of Dark Pool Trading from Mohammad Daniyal's blog

Dark pool (DP) trading, also referred to as the upstairs market, can benefit both institutional and retail traders. DP transactions represent block trades that occur outside the central exchanges. Information about such trades is concealed from the public, but only during the pre-trade phase of the transaction. Once the trading sentiment is executed, the activity is reported to the consolidated tape, which records all official transactions. Many liquidity traders feel that all trades should be revealed to the public, but there are also many defenders of off-exchange transactions.

The purpose of concealed institutional trading is to guard against spikes in the price of a security. Releasing information prior to the execution of a trade would alert the marketplace of a significant spike in volume, which could affect the cost of the negotiated transaction. Since institutional trades often involve millions of shares, even a small price fluctuation can increase the cost of a trade substantially.

In recent years, there has been a significant increase in the use of institutional transactions by brokers and investors. The investment strategy, often involving smaller blocks of frequently traded securities, has been made possible by the availability of fast-acting computer algorithms. Once again, the trade is only hidden from view during the initial phase of a transaction, when the buyer and seller are agreeing upon an acceptable price.

Aside from temporarily protecting a potential transaction from public view, concealed liquidity pools also allow financial institutions and brokers to shop for securities at a given price. Many pension and mutual funds utilize institutional transactions and liquidity pools to reduce costs, move low-volume securities, and conduct anonymous transactions. Electronic trade platforms are highly efficient and cost-effective.

The escalating number of off-exchange transactions has the potential to keep the marketplace from discovering and influencing stock and equity prices. Nevertheless, many knowledgeable investors believe that off-exchange transactions ultimately reduce the cost of securities for private investors, due to the efficiency and flexibility of electronic institutional transactions. It is also believed that off-exchange stock deals improve liquidity for the average investor. Such trades tend to find an acceptable point between the bid and ask price. The use of dark pool transactions by institutional traders to keep the market from moving against a given price, allows average investors to benefit from lower overall stock prices. Off-exchange institutional transactions also make it possible for brokers to move hard to sell securities and balance investor portfolios.

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