“Dark pools disrupt orderly operation of markets” says OTAS Tom Doris

Tom Doris (pictured), CEO of OTAS Technologies, comments on the recent dark pool trading scandals.

Dark pools only make sense if you have short term alpha. Large institutional investment firms do not have a short-term edge and therefore should not trade in the dark. Dark pools conceal material information from the market.

Free efficient markets are predicated on timely public access to price and volume information. Dark pools can disrupt the orderly operation of markets and can be gamed and manipulated by predatory participants and the pool operators. They are not subject to the same regulation/scrutiny as lit venues and therefore participants will never be afforded the same protections.

Nobody can prove how dark a pool actually is – the operator can always see the content of the pool, and as the operator’s organisation changes and market conditions change, the visibility can be changed as a matter of policy.

At some point, every operator will attempt to “monetize” the content of the pool in new ways. Almost nobody systematically measures the behaviour of the dark pools, they trade on to establish whether they are being picked off by predatory firms with short-term alpha. They take it on trust from the pool operator.

As for negative selection: Getting filled at the mid-price is a good result in the short term for the trader, because it gets the order off his pad and he has achieved “price improvement”.

But it’s not a good result for the fund if the fills are always on stocks that are at better prices an hour later. This is “negative selection”: let’s say you’ve got 10 buy orders in the dark pool. You get filled on 5. The price of the 5 stocks you got filled on tends to decrease over the next few hours, meaning that if you’d waited you could have bought them cheaper in the lit markets.

The price of the 5 you didn’t get filled on tends to go up, meaning you have to pay more for them and you’ve lost time in doing so by posting the order to the dark pool. Even if you do measure everything properly, there are types of negative selection (“short sharp shocks”) that predatory firms can employ that won’t appear statistically significant but that can cost a lot”

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