Dark Pools and High Frequency Trading For Dummies
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It’s a risky market out there, no doubt about it. Dark pools aren’t transparent (the clue is in the name), which raises many questions and concerns as to what is going on when an investor sends an order out to the market. Many dark pools have faced fines or are the targets of ongoing investigations and fines from regulators, which hasn’t helped the cause of dark pools. The continuing fines and lawsuits have caused a crisis of trust within the financial markets.

Here are a couple of risks for trading in dark pools you need to be aware of:

  • Front running: Front running basically means that someone gets to see your trade first and jumps in front of you, buying ahead of you when you want to buy, and then selling to you for a higher price.

  • Being fodder for high frequency traders: High frequency traders can use tactics that make you pay more when you’re buying stocks and receive less when you’re selling stocks.

  • Lack of transparency: Because dark pools don’t display their orders, knowing whether you have received the best possible price at the time when your order was executed is difficult.

To mitigate these risks, know the dark pools your broker uses and then see whether those dark pools have been fined or are under investigation. If you find your broker using these dark pools, you can always ask her not to route through the dark pools that worry you the most. Asking your broker isn’t without risk, though, because it becomes a matter of trust. How much do you trust your broker?

Verifying that your broker is routing exactly as you want can be difficult. Because trade entry is often automated, your broker may not have much control of the routing of the order, which means you still remain in the dark.

The world of dark pools is a constantly changing market. If you’re investing via the markets, you need to pay close attention to the public discussion concerning dark pools. The rule today may change tomorrow. If you can keep up with the discussion, know the good guys from the bad guys and identify quickly any changes that are happening then you’ll be able to trade more safely in the markets.

About This Article

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About the book author:

Jay Vaananen is a senior private banker with many years of experience advising clients in their investments across all asset classes. He is also a popular university lecturer and regular commentator in all matters regarding banking, finance and investing.

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