Luuu-ke: Come to the daaark side.
If you only knew the power of the dark side. (click quote to play sound clip)
Ok ok. Pretty geeky but all this talk about “dark” liquidity pools made me think of ol’ Darth… but hey if it’s in the FT (read today before it dives behind the FT pay-ramparts…), we’re talking mainstream now:
Banks begin to dip into ‘dark pools’ (By Anuj Gangahar in New York Published: October 18 2006 21:25)
Morgan Stanley is joining the growing list of banks that are challenging stock exchanges by forming “dark liquidity pools”, internal trading platforms that anonymously match buy and sell orders.
The dark pools, also known as dark books or internal crossing networks, pose a potential competitive threat to exchanges, by internally matching orders without publishing quotes – a service that is particularly popular with traders using computer-executed strategies.
Google ‘dark pools liquidity’ and you’ll find about 150k entries; now I don’t know that all these are relevent, but for anyone looking to find out more the first 30 or so entries are not a bad place to start (are they allowed to use Google at the FT?). For instance, this article from FinanceTech picked up on the emerging phenomenon in October…2005:
Several brokers are designing algorithms that sweep crossing networks and so-called dark books - liquidity pools that match buy and sell orders without publishing a quote. Similar to crossing networks, dark books are an alternative to the public equity markets that brokers are exploring for their algorithmic trades.
Regular readers will already know that I am (probably over-) fascinated by how semantics and accepted frames of reference influence not only how change is reported on but (imo) actually how the incumbents prosecute their adaptive strategies and approach emerging opportunities. A sceptic would say that - whether or not my hypothesis is actually true, assuming even that it is - the end result is/will be more or less the same, so really this type of observation is superfluous intellectual masturbation… I would dispute this on two fronts. First, I’m not 100% in agreement that the end result is not path-dependant, especially as financial services are highly regulated. ie There is ample scope for the end-game to be mandated as a function of the frame of reference (both regulatory and cultural.) Without a alternative paradigm, the number of possible outcomes is significantly limited and will ultimately and necessarily be some derivative of the existing paradigm. iow - You can’t teach an old dog new tricks…
One of the points, I tried to make in AmazonBay was that there was significant potential (whether or not any individual or firm saw this as an opportunity to be embraced or a risk to be feared is an extremely important - but separate - question…) for a someone and/or some firm with a different perspective to effect a quantum transformation the existing paradigm. Not inevitable - far from it giving the intrinsic and external barriers that protect the financial services business - but possible…
So what has this got to do with algorithmic trading or dark liquidity or Darth Vader? Well without wanting to disparage any of the fantastically bright and innovative people and firms in the existing financial firmament, I don’t think it is crazy to wonder if others outside the industry have potentially equal or better adapted technology for the future of trading… now for sure, there is nothing to say that the “incumbents” can’t or won’t (or haven’t already) adopt/acquire/develop these same technologies; it will be interesting to see if they do. In other words (apologies to Ms Stein): “An algorithm is an algorithm is an algorithm.” …if you know what I mean.
Finally, lest you think that this is all just some far-fetched and irrelevent conversational dead-end, I think we are currently living an analogous tug-of-war (between old and new paradigms) in one or two other industries. One only has to look at the current battles going on within the telecommunications and media sectors to see how unsettling it can be for incumbents - firms who’s very foundations are predicated on an existing industrial paradigm - that are faced not only with new upstart competitors (you win most/you lose rarely) but with a completely new competitive and industrial frame of reference (the hey-that’s-not-fair-you-should-only-be-allowed-to-compete-on-the-terms- we-are-comfortable-with-problem… or “htnfysobatcottwacwp” for short.) If I was running an investment bank (which of course I’m not 
), I’d be watching closely from the sidelines and taking notes…
November 2nd, 2006 at 4:33 pm
if broker-dealers’ internal crossing systems provide liquidity that wasn’t available before, other people will want to access those pools. Whats needed is one giant black box that has access to all these liquidity pools.”
November 4th, 2006 at 3:11 am
Whilst the talk of Dark Pool’s is engaging the real issue is the fragmentation of market liquidity as a whole. I am certain that banks will continue to come up with catchy names for algorithms that sound far better than performance dictates.
However smart the algo is at accessing an increasing number of liquidity points, accessing these points will have a direct impact on ‘Implementation shortfall’. As the number of pools increase where is the infection point where accessing these pools becomes counter productive and the search itself increases the risk of gaming?
Fear and Greed springs to mind. If the exchange is no longer the central liquidity point do you sweep all of the pools of liquidity, some of them or none of them? Take Posit for example. Automating the process of posting takes the sweat out of the crossing process. But how can you have any effective pre-trade analysis where the time out of the market is random? Or what is the cost of trudging all over the jungle looking under every leaf?
When the ‘Gorilla’ leaps from the undergrowth to capture any liquidity is there a bigger monster that eats Gorilla’s waiting near by?
November 16th, 2006 at 11:00 am
From Goldmans:
http://www.finextra.com/fullstory.asp?id=16145
September 28th, 2007 at 2:44 pm
[…] Next up was Robert Barnes (MD, UBS) with a snappy presentation entititled “Dark liquidity and the changing trading environment” (some of my ramblings on the subject from last year are here). […]