5 ms·

> how seemingly good intentions created the market we have today. It's been a bit since I read Flash Boys [edit: didn't realize you were talking about a differ

by ethbro 12y ago

> how seemingly good intentions created the market we have today. It's been a bit since I read Flash Boys [edit: didn't realize you were talking about a different book], but from memory dark pools were never created with good intentions. At best, they were created with the intention of enabling cheaper trades by not having to route orders to the broader public market (just like a colo CDN)? And dark pool owners had all the information needed to gather real-time reporting on the prices predatory dark pools were trading normal investors' orders at vs. the broader market price. Which is to say, they absolutely knew they were screwing someone.

tptacek 12y ago
It's tough to discuss dark pools for a couple reasons. First, they have a sinister name. Second, they're generally run by giant financial firms, who nobody likes right now. Third, they're a fuzzy concept. In reverse order: A dark pool is really just a private exchange, or really just what you'd call anything that functioned in any way like a private exchange. They're a tool, deployed to solve problems for (primarily) large investors. When you start talking about market structure and facilities, it can get pretty weird to talk about "intentions". Major exchanges are also routinely used for shady transactions! The best-known purpose (or "intention") of a dark pool is to allow huge buy-side institutional investor to move large blocks of securities. If you don't spend much time reading about market microstructure, you're probably unaware that this is one of the fundamental problems in trading.† Market "physics" dictate that there is no instantaneous price available for the sale of a large block of securities. A huge order will gobble up many orders off the order book, and, as it executes over time, it moves prices --- the intent of a large investor to dump a lot of securities on the market is extremely relevant to everyone else in the market, and to the correct price of that security. The best known dark pools tend to be owned by giant investment banks and similar firms. This should be unsurprising, because one of the key services those firms offer their clients is "efficiently shopping or buying large blocks of securities". To deliver that service on open exchanges, they have to compete with other firms that are aggressively trying to detect big moves and profit from quickly making prices reflect those moves, often while the move is happening. The participants in a dark pool are cooperating to "more efficiently" move large blocks in private without impacting prices (as much) while the move is happening.†† (Dark pools also end up executing some retail order flow as well; as "private exchanges", they're also a useful service for their operators to be able to sell to retail brokerages. They take on the task of trying to ensure orders are executed quickly, and their other trading clients get exposure to retail order flow, which is demographically likely to be uninformed and profitable to trade against.) Finally: the name. It sounds Death Star-ish. But really it's just a comparison to normal "lit" exchanges, where order books are visible to participants. "Lit" and "dark". It might seem like lack of transparency and visibility into prices could be a license for all sorts of shady stuff. And some shady stuff happens (apparently most of which has to do with the promises made to dark pool clients when they agree to execute orders there). But most of the "shenanigans" that drive concerns about HFT require order visibility (I like to suggest that they are direct consequences of the CAP theorem, applied to electronic markets). † Bafflingly, a huge and apparently valid complaint about _Flash Boys_ is that Lewis --- a former bond salesman --- doesn't seem to understand this fact. †† I suspect we'll find that when we start ascribing motives and intentions and morality to market activities, we'll quickly find out that this stuff is all murky, and that almost any activity can be "shady" or "virtuous" viewed through the right lens. For instance: some dark pool controversy involves big pools persuading big investors to execute trades on their pools, whereupon they're "victimized" by HFTs and other aggressive traders. Through the lens of "promises should be kept" and "truth in advertising", this is bad. But through the lens of "giant financial firms probably shouldn't have a special sneaky execution lane for dumping a zillion shares on the market without alerting other investors that they are moving the market", things look a bit different.
- minimax 12y ago
  The best-known purpose (or "intention") of a dark pool is to allow huge buy-side institutional investor to move large blocks of securities. That is the raison d'être for only a couple of dark pools (mostly the older ones like liquidnet). The reason most big i-banks have their own dark pools is because it's cheaper to trade on their own ATS than it is on most of the public exchanges. The "take fee" paid by anyone crossing the spread on the 5 biggest exchanges (by volume) is usually in the range of $0.0025 - $0.0030 per share, which doesn't seem like a huge number, but it can add up when you are trading tens or hundreds of millions of shares daily. If banks can trade customer and internal flow on their own ATS, they don't have to pay those fees. You can look at the average trade sizes broken down by symbol and ATS. The data is here: https://ats.finra.org https://ats.finra.org. The average trade size for most ATSs is somewhere between 100-200 shares. The whole "dark pools are for crossing large blocks" thing is sort of anachronistic these days.
  - tptacek 12y ago
    I was hoping someone would come and provide this additional color. Doesn't this fact reduce the moral implications of dark pools, though?
    - minimax 12y ago
      There are a couple of complaints I have seen. 1) That orders that are "pegged" to the NBBO at dark pools may execute at inferior prices relative to the true NBBO. If the market moves from 20.23 x 20.24 to 20.24 x 20.25, you can in theory try to quickly buy in the dark pool at 20.235 and lay off by selling at 20.24 in the lit market. The theoretical per-share profit would be 0.005 before fees and probably zero after. This is the whole point of the IEX 40 (or whatever) miles of fiber in your order entry path. It gives IEX the opportunity to update their view of the NBBO while your order spins around in the coil. I think the issue is partly intrinsic to pegged orders. The pegged order is effectively getting a free ride re pricing based on the the price discovery happening in the lit markets. Maybe that is a natural trade-off? I actually read a really good blog post recently where a guy tried to work out what would happen if more exchanges tried these sorts of delay gimmicks. It's worth a read if you're interested. https://mechanicalmarkets.wordpress.com/2015/03/03/should-iex-become-a-full-exchange-incentives-for-exchanges-to-compete-by-increasing-delays/ https://mechanicalmarkets.wordpress.com/2015/03/03/should-ie... 2) The Barclay's thing where the claim is that Barclay's could prevent you from trading with certain counterparties or types of counterparties but maybe they didn't? It's been in the news but I don't think anything has really been settled. One interesting thing is that the court case is between the NY attorney general and Barclay's, not between Barclay's and any of Barclay's (presumably legally sophisticated and deep pocketed) customers. 3) Unsophisticated or low-cost order routers that sequentially try to trade at various dark pools signal to the market makers who are quoting on those dark pools that someone was potentially trying to sweep. If you think market makers should be able to use this kind of information to avoid being adversely selected against on their other orders, then it probably doesn't bother you, but it bothers people like Michael Lewis. A crappy order router can let out a lot more signal than a good one. It seems like the kind of thing you could A/B test but I don't work on the buy-side so I'm not sure what they do.

by ethbro 12y ago

tptacek 12y ago

It's tough to discuss dark pools for a couple reasons. First, they have a sinister name. Second, they're generally run by giant financial firms, who nobody likes right now. Third, they're a fuzzy concept. In reverse order: A dark pool is really just a private exchange, or really just what you'd call anything that functioned in any way like a private exchange. They're a tool, deployed to solve problems for (primarily) large investors. When you start talking about market structure and facilities, it can get pretty weird to talk about "intentions". Major exchanges are also routinely used for shady transactions! The best-known purpose (or "intention") of a dark pool is to allow huge buy-side institutional investor to move large blocks of securities. If you don't spend much time reading about market microstructure, you're probably unaware that this is one of the fundamental problems in trading.† Market "physics" dictate that there is no instantaneous price available for the sale of a large block of securities. A huge order will gobble up many orders off the order book, and, as it executes over time, it moves prices --- the intent of a large investor to dump a lot of securities on the market is extremely relevant to everyone else in the market, and to the correct price of that security. The best known dark pools tend to be owned by giant investment banks and similar firms. This should be unsurprising, because one of the key services those firms offer their clients is "efficiently shopping or buying large blocks of securities". To deliver that service on open exchanges, they have to compete with other firms that are aggressively trying to detect big moves and profit from quickly making prices reflect those moves, often while the move is happening. The participants in a dark pool are cooperating to "more efficiently" move large blocks in private without impacting prices (as much) while the move is happening.†† (Dark pools also end up executing some retail order flow as well; as "private exchanges", they're also a useful service for their operators to be able to sell to retail brokerages. They take on the task of trying to ensure orders are executed quickly, and their other trading clients get exposure to retail order flow, which is demographically likely to be uninformed and profitable to trade against.) Finally: the name. It sounds Death Star-ish. But really it's just a comparison to normal "lit" exchanges, where order books are visible to participants. "Lit" and "dark". It might seem like lack of transparency and visibility into prices could be a license for all sorts of shady stuff. And some shady stuff happens (apparently most of which has to do with the promises made to dark pool clients when they agree to execute orders there). But most of the "shenanigans" that drive concerns about HFT require order visibility (I like to suggest that they are direct consequences of the CAP theorem, applied to electronic markets). † Bafflingly, a huge and apparently valid complaint about _Flash Boys_ is that Lewis --- a former bond salesman --- doesn't seem to understand this fact. †† I suspect we'll find that when we start ascribing motives and intentions and morality to market activities, we'll quickly find out that this stuff is all murky, and that almost any activity can be "shady" or "virtuous" viewed through the right lens. For instance: some dark pool controversy involves big pools persuading big investors to execute trades on their pools, whereupon they're "victimized" by HFTs and other aggressive traders. Through the lens of "promises should be kept" and "truth in advertising", this is bad. But through the lens of "giant financial firms probably shouldn't have a special sneaky execution lane for dumping a zillion shares on the market without alerting other investors that they are moving the market", things look a bit different.

minimax 12y ago
The best-known purpose (or "intention") of a dark pool is to allow huge buy-side institutional investor to move large blocks of securities. That is the raison d'être for only a couple of dark pools (mostly the older ones like liquidnet). The reason most big i-banks have their own dark pools is because it's cheaper to trade on their own ATS than it is on most of the public exchanges. The "take fee" paid by anyone crossing the spread on the 5 biggest exchanges (by volume) is usually in the range of $0.0025 - $0.0030 per share, which doesn't seem like a huge number, but it can add up when you are trading tens or hundreds of millions of shares daily. If banks can trade customer and internal flow on their own ATS, they don't have to pay those fees. You can look at the average trade sizes broken down by symbol and ATS. The data is here: https://ats.finra.org https://ats.finra.org. The average trade size for most ATSs is somewhere between 100-200 shares. The whole "dark pools are for crossing large blocks" thing is sort of anachronistic these days.
- tptacek 12y ago
  I was hoping someone would come and provide this additional color. Doesn't this fact reduce the moral implications of dark pools, though?
  - minimax 12y ago
    There are a couple of complaints I have seen. 1) That orders that are "pegged" to the NBBO at dark pools may execute at inferior prices relative to the true NBBO. If the market moves from 20.23 x 20.24 to 20.24 x 20.25, you can in theory try to quickly buy in the dark pool at 20.235 and lay off by selling at 20.24 in the lit market. The theoretical per-share profit would be 0.005 before fees and probably zero after. This is the whole point of the IEX 40 (or whatever) miles of fiber in your order entry path. It gives IEX the opportunity to update their view of the NBBO while your order spins around in the coil. I think the issue is partly intrinsic to pegged orders. The pegged order is effectively getting a free ride re pricing based on the the price discovery happening in the lit markets. Maybe that is a natural trade-off? I actually read a really good blog post recently where a guy tried to work out what would happen if more exchanges tried these sorts of delay gimmicks. It's worth a read if you're interested. https://mechanicalmarkets.wordpress.com/2015/03/03/should-iex-become-a-full-exchange-incentives-for-exchanges-to-compete-by-increasing-delays/ https://mechanicalmarkets.wordpress.com/2015/03/03/should-ie... 2) The Barclay's thing where the claim is that Barclay's could prevent you from trading with certain counterparties or types of counterparties but maybe they didn't? It's been in the news but I don't think anything has really been settled. One interesting thing is that the court case is between the NY attorney general and Barclay's, not between Barclay's and any of Barclay's (presumably legally sophisticated and deep pocketed) customers. 3) Unsophisticated or low-cost order routers that sequentially try to trade at various dark pools signal to the market makers who are quoting on those dark pools that someone was potentially trying to sweep. If you think market makers should be able to use this kind of information to avoid being adversely selected against on their other orders, then it probably doesn't bother you, but it bothers people like Michael Lewis. A crappy order router can let out a lot more signal than a good one. It seems like the kind of thing you could A/B test but I don't work on the buy-side so I'm not sure what they do.