Let’s say you’re a large pension fund that wants to buy 100,000 shares of Apple. If you enter such a large BUY order into the market, it would drive the price up. Of course, you don’t want to pay any more than necessary. So, what do you do?
You enter a “dark pool.” Large financial institutions maintain these dark pools. If you want 100,000 shares of Apple, somebody else in the dark pool, another client of the institution, might be willing to sell them to you at whatever price you agree. The large financial institution acts as the middle-man in this.
But, it is kept secret from other investors, until it is too late for them to react to the news. If sunlight is a disinfectant, dark pools must be nasty.
They are! Plus, dark pools are a godsend for high-frequency traders, who can react instantly. But, not you!
Assuming you’re just a normal investor with 100 shares of Apple to sell, you want the best price and you did not get it, because nobody knew a huge buyer was lurking in the dark pool.
In the U.S., some estimate that as much as 40% of all trades may be done in these dark pools. Last year, the European Union limited this to only 8% of their trades, but it is still unclear how effective this has been.
Janitors know you can use TOO MUCH disinfectant, but there is no such thing as too much sunlight in the securities markets, where we need less secrecy and more transparency!