This paper examines the characteristics of equity trading and especially two relatively new phenomenons which are dark pools and flash trading. Over the last years these two terms became more and more important in equity trading and today they are a real alternative to traditional exchanges, like the New York Stock Exchange or Deutsche Börse. But these new evolutions do not only have advantages. Indeed there are concerns that beside the benefits, like fast execution times, sophisticated techniques and less market impact, these mechanisms can also burrow risks. These risks are difficult to estimate, with an evolution of these new platforms that was so quick, that one might have the impression that even regulators do not full yet understand what might happen in the case of a next financial crisis.
However with a market share of 15%-20% of all trading activity in global equities and a jump of almost fivefold in the period of time from January to October 2009, these new mechanisms cannot be ignored anymore. Therefore this paper explains in detail the functionality of dark pools and other current trading strategies. All important factors like different market structures, market liquidity aspects, as well as regulatory framework and technology facets will be reviewed. Further an outlook should be given to the reader on how the evolution of dark pools & co. might continue in the coming years.
With dark pools and flash trading, trading is now dominated by rapid-fire computer systems that might create a more technically driven market, rather than one based on fundamental forces. It remains to see whether this evolution will continue.
Table of Contents
1. Introduction
2. Equity Trading and its new phenomenons – Definitions and Characteristics
2.1 What is Equity Trading?
2.2 Dark Pools – Definition
2.3 Dark Pools – Rationale
2.4 The Trading Framework
2.4.1 Pre-trade phase
2.4.2 Trade phase
2.4.3 Post-trade phase
2.5 Orders
2.5.1 Market Orders
2.5.2 Limit Orders
2.5.3 Peg Orders
2.5.4 Hybrid and Complex Orders
2.5.5 Order Parameters
2.5.5.1 Display Parameters
2.5.5.2 Quantity Parameters
2.5.5.3 Time in force Parameters
3. Different types of Market Structures and Market Liquidity
3.1 Physical and electronic markets
3.2 Continuous Markets
3.3 Quote-driven and order-driven markets
3.4 Displayed and nondisplayed markets
3.5 Market Liquidity
3.5.1 Block liquidity
3.5.2 Supply and demand for liquidity
4. Pricing in the dark pool sector
4.1 Price discovery
4.2 Price derivation
5. Regulatory Framework and Control in Europe
5.1 Regulatory Framework in Europe - MiFID
5.2 Financial Regulation and Dark Pools
5.3 Reporting and transparency
6. The structure of dark pools
6.1 Exchange orders and brokers as sources of dark liquidity
6.2 Multilateral Trading Facilities (MTFs) as sources of dark liquidity
6.2.1 Electronic limit order books
6.2.2 Crossing Networks/Price Reference Systems
6.3 Broker desks as sources of dark liquidity
6.4 Direct market access (DMA) as source of dark liquidity
6.5 Hybrid business models as sources of dark liquidity
6.6 Market overview
6.7 Dark sector evolution
7. Trading in the dark
7.1 Execution issues
7.2 Trading Strategies
7.2.1 Block Trading
7.2.2 Program Trading
7.2.3 Algorithms and Algorithmic Trading
7.2.4 High Frequency Trading
7.2.5 Gaming
7.3 Aspects of Technology
7.3.1 Order Management Systems and Execution Management Systems
7.3.2 Routing Engines
7.3.3 Matching and Pricing Engine
7.3.4 The FIX Protocol
8. Conclusion – The future of dark pools and flash trading
Research Objectives and Topics
This paper aims to provide a comprehensive understanding of equity trading, with a particular focus on the rise of dark pools and flash trading. It explores how these mechanisms have evolved, their role in modern market structures, the impact of technological innovation, and the current regulatory landscape in Europe, while investigating the trade-offs between market transparency and execution efficiency.
- Evolution and current state of dark pools and nondisplayed liquidity.
- Impact of technological advancements on electronic trading and execution.
- Analysis of market structure, liquidity, and the mechanisms of price discovery.
- Regulatory challenges, including the Markets in Financial Instruments Directive (MiFID).
- Trading strategies, including high-frequency trading and algorithmic execution.
Excerpt from the Book
2.5.5.1.2 Iceberg Orders
Iceberg orders (also known as reserve orders) are orders which make it possible to an investor to place orders with huge volume into the order book without making the whole volume visible to the public. Iceberg orders are limit orders with a defined total volume as well as a defined visible part of the order, the so called peak-volume. Both, the total volume as well as the peak-volume, have to match a so called round lot, which means that the volume of an iceberg order has to be a normal unit of trading for a security, which are generally 100 shares of a stock.
In the continuous trading when the first peak has been fully executed, another peak is automatically displayed in the order book. The hidden part of the order is then reduced by the corresponding number of shares. When an iceberg order’s displayed part is fully executed, and the next peak converts from hidden to displayed status in the order book, the newly displayed peak also receives a new time stamp which determines its time priority (Banks, 2010: 42).
For instance, if the total volume of an iceberg order is 100,000 shares and the peak volume is defined as 10,000 shares, the market would see only 10,000 shares on the ask or bid side of the order book, depending whether the order would be a buy or a sell order. When the display quantity of 10,000 shares would be executed, the next peak volume would be automatically visible to the market, and wait for its next opportunity to get a fill. The trading system automatically displays new peaks after additional executions, until the final peak is displayed or the order is cancelled. As iceberg orders are not specially marked in the order book, it is not visible from the outside whether an order has a rest volume or not. Only after the full execution the total volume is visible. But the immediate automatic display of a new peak after the currently displayed peak is executed creates a distinct pattern in the order book updates that is observable to any
Summary of Chapters
1. Introduction: Outlines the historical evolution of electronic trading and the emergence of dark pools as a significant market phenomenon.
2. Equity Trading and its new phenomenons – Definitions and Characteristics: Provides foundational definitions for equity trading and dark pools, alongside an overview of trading phases and order types.
3. Different types of Market Structures and Market Liquidity: Discusses various market models and the central role of liquidity, including the impact of large block trades.
4. Pricing in the dark pool sector: Explores the mechanisms of price discovery and derivation within both visible and dark trading environments.
5. Regulatory Framework and Control in Europe: Examines the regulatory landscape, specifically focusing on the MiFID directive and its impact on transparency and competition.
6. The structure of dark pools: Highlights the various sources of dark liquidity, including MTFs, broker desks, and hybrid business models.
7. Trading in the dark: Analyzes execution issues and sophisticated trading strategies, such as algorithms and high-frequency trading.
8. Conclusion – The future of dark pools and flash trading: Summarizes key findings and reflects on future trends, including industry consolidation and technological development.
Keywords
Dark pools, Equity trading, MiFID, Market liquidity, High frequency trading, Algorithmic trading, Electronic trading, Price discovery, Order routing, MTF, Market structure, Block trading, Information leakage, Execution, Financial regulation.
Frequently Asked Questions
What is the core subject of this publication?
The book provides an in-depth analysis of equity trading, focusing on the development and operation of dark pools and modern trading phenomena like flash trading within current market structures.
What are the central thematic fields covered?
The main themes include the evolution of nondisplayed liquidity, the technological infrastructure of modern exchanges, regulatory frameworks (specifically MiFID), and the strategies institutional investors use to execute large trades.
What is the primary objective of this work?
The work seeks to give the reader a thorough understanding of the "dark" trading landscape, explaining the benefits, risks, and mechanisms that define how capital is moved efficiently in modern markets.
Which scientific methodology is applied?
The author utilizes a descriptive and analytical approach, synthesizing existing industry literature, regulatory documents, and market data to map the structure and evolution of the dark pool sector.
What topics are discussed in the main chapters?
The chapters cover definitions of trading, market structure and liquidity, pricing mechanisms, the European regulatory environment, sources of dark liquidity (MTFs and broker desks), and technical trading strategies like algorithmic and high-frequency trading.
Which keywords best characterize the work?
Key terms include Dark pools, MiFID, Market liquidity, High frequency trading, Algorithmic trading, and Price discovery.
How does the author define a "dark pool"?
A dark pool is defined as a venue or mechanism containing anonymous, non-displayed trading liquidity that allows investors to execute orders away from public order books to minimize market impact.
What is the role of the FIX Protocol in this context?
The FIX Protocol serves as the industry-standard messaging language, enabling the rapid and consistent communication necessary for electronic trading and the integration of OMS and EMS systems.
Why is the "Thirty-Millisecond Advantage" significant?
It illustrates how high-frequency traders use speed to identify incoming order flow from slower institutional investors, allowing them to anticipate price movements and capture small, cumulative profits.
What are the future trends predicted for the sector?
The author predicts further industry consolidation, increasing sophistication in algorithmic trading, and continued growth in dark trading volumes as global capital seeks execution efficiency without significant market impact.
- Quote paper
- Katharina Niciejewska (Author), 2012, Dark Pools and Flash Trading. New trends in Equity Trading?, Munich, GRIN Verlag, https://www.grin.com/document/285140
