Hot Stock Minute

What is the "dark market?"

Michael Lewis’ book “Flash Boys” brought public scrutiny to high-frequency trading. The book alleges that high-frequency traders have an advantage over the rest of the market. Lewis himself said, the stock market is “rigged.”

The attention on high-frequency trading has drawn attention to another little-known aspect of stock trading: the ominously-named “dark markets.” Trades in these dark markets, or dark pools, don't have the same transparency as exchanges. Buyers and sellers meet directly and trades occur without quotes or shares being displayed on exchanges in real time.

Dark markets may be more of a growing problem compared to high-frequency trading. Revenue from high-frequency trading declined from $5 billion in 2009 to $1 billion last year. Meanwhile, as much as 40% of all U.S. stock trades now occur outside of exchanges in dark markets, up from about 16% six years ago.

Yahoo Finance Senior Columnist Michael Santoli spoke with Lauren Lyster about the rise of dark trading pools. He said "off-exchange" trading emerged as a workaround when investors started trading in pennies and decimals and found it difficult to complete big trades in such small amounts on the main exchanges without impacting stock prices to their disadvantage. Now, the small workaround has grown to the point where it is competing with the mainstream market. "Essentially they’ve become so big that they’re actually rivaling the size of the overall listed, quoted market.”

Santoli said what would make this a problem is if what is quoted in the public exchange is significantly different from the prices quoted in the dark pool. “That’s not really the case, at least not consistently,” he said.

Santoli said the outrage over high-frequency trading will make everything open for questioning. He said there may be an examination of the “fragmented, rickety market structure.”

“I do think you might have some efforts to centralize and rationalize it come into play,” he said.

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