“Unless there are some changes, there’s going to be a massive crash, a flash crash times ten.” Ron Morgan and Brian Levine, Goldman Sachs
As recently as 2005, dark pools made up 3% to 5% of trading activity. Today, it’s 12%.
Dark pools are like fraternal clubs, but without the secret handshake. No one talks about them, so they’re a mystery to the world at large. Many were unfamiliar with dark pools until this past week, when The Wall Street Journal announced that Goldman Sachs is planning to close its Sigma X dark pool, which is one of the industry’s largest and darkest pools. (Goldman has not confirmed that action.)
So what is a dark pool? It’s a stock exchange where trading takes place in the “dark,” which means the size and price of orders are not revealed to other participants.
To some extent, dark pools are a reaction to high-frequency trading (HFT), which we discussed last week and in other previous posts. When trades take place in the dark, algorithmic traders can’t take advantage of them.
Theoretically, if dark trades, which are typically high volume trades, took place in the light of day, high-frequency traders would amplify the impact of such trades and potentially cause another flash crash. Or worse.
But on Wall Street, of course, nothing is ever that simple. There’s more to dark pools than that. Consider some of the questions that dark pools raise: