What Is a Dark Pool — The Invisible Exchange
Outside the exchange, there are trades that pass back and forth without ever appearing on the order book. The dark pool, meaning 'dark pond' — what on earth is it?
Definition of a dark pool
A dark pool is a private trading venue that executes orders without displaying them in the public quotes. It is a type of Alternative Trading System (ATS) rather than a regular exchange.
The name 'dark' comes from the fact that orders do not appear in the public order book.
Institutional investors mainly use it to execute large orders without exposing them to the market. It is to avoid the market impact where a large block appearing in the order book moves the price unfavorably.
Regulation and market share
Dark pools are not illegal; they operate under regulation. In the United States they are subject to Regulation ATS, introduced in 1998, and Regulation NMS, and in 2018 Form ATS-N, which strengthened disclosure, was introduced.
The scale is tallied differently by source. Pure dark pool (ATS) trading is estimated at roughly 15–18% of U.S. stock trading volume, while many sources say that 'total off-exchange,' including internalization by wholesale market makers, reaches about 40–45%.
Off-exchange trades are also reported after the fact through FINRA's Trade Reporting Facility (TRF), and the volume by ATS is disclosed with roughly a two-week delay.
The share of 'dark pools' and of 'total off-exchange' varies by source because definitions differ, so the figures range from 15% to 45% (pure ATS about 15–18%, total off-exchange about 40–45%). That is why it is shown as a range.
What it means for individual investors
Assessments surrounding dark pools are split.
Positively, there is the view that they keep institutions' large orders from shaking the public market, thereby reducing volatility.
Negatively, there is the criticism that a substantial portion of trading happens 'out of sight,' weakening price discovery and transparency.
It is rare for an individual investor to place orders directly into a dark pool. That said, you do need to know the fact that 'the order book I see shows only part of all trading.'
Frequently Asked Questions
Q. Are dark pools illegal?
No. In the United States they operate legally under regulations such as Regulation ATS and NMS, and trades are reported to FINRA after the fact. That said, the criticism that transparency is low and discussions of tighter regulation have continued.
Q. If dark pool trading is that large, is the order book meaningless?
It is not that it is meaningless, but you must know that the public order book does not show all trading. Since a considerable amount of volume passes back and forth off-exchange, it is hard to judge the whole market by the supply and demand on screen alone.
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