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Tuesday, November 20, 2012

Dark pools and unintended consequences

More on the law of unintended consequences

So the story goes something like this... Before computers, all trading was manual, literally, traders would receive a paper list of orders (what to buy and sell) they would take that list to the pit and find counter parties .. Not ideal, not transparent, ... I know... Along came computers and financial derivatives and we thought that the more we traded the better prices we could get... (Better as in more efficient, (more information embedded in the price)).  And trading exploded... 24 x 7 around the world, every possible asset.

Along came HFTs, high frequency traders who use sophisticated computer algorithms to trade securities on a very rapid basis, as in thousands of orders per second... (yes per second). Check this great NYT article about them.  

If more trading was good for the market... then HFT must be very good... right? Wrong! At least that is what some of the big players are saying... It turns out that dark pools (trading that takes place outside regular markets) are growing.  In fact, an estimate says around 30% of all trading volume in the US is conducted in these pools. Very well explained in this FT note.

If the big guns don't like it, why should I?

Maybe we are going back to the human trader...

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