Often brokers advise their access to a 'huge' dark pool. If I were an institution trading big lots, then surely I would choose a broker like this. But as a retail trader, does this influence my choice of a broker ?

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    Do retail brokers use their access to dark pools as a selling point? – Ellie Kesselman Dec 22 '14 at 2:47
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    First of all if you are posting questions about dark pool on this website, you aren't that big fish to be allowed to trade in the dark pool. And which broker told you about a dark pool ? – DumbCoder Dec 22 '14 at 9:09

That's like a car dealer advertising their "huge access" to Chevrolet. All brokers utilize dark pools nowadays, either their own or one belonging to a larger financial institution. Why? Because that's a primary source of broker income. Example:

  • Retail investor 'Mom' sends a market order to F*TRADE to sell 100 AAPL at the highest price currently available. Let's say that's $99.99.
  • Retail investor 'Pop' sends a market order to F*TRADE to buy 100 AAPL at the lowest price currently available. Let's say that's $100.00.

Under current US regulations the broker is under no obligation to pass these orders to actual (a.k.a. lit) exchanges. Instead it can internalize them in its dark pool as long as it "improves the price". So:

  • F*TRADE gives Mom $9999.01 for her shares (at the improved price of $99.9901 per share).
  • F*TRADE gives them to Pop and takes $9999.99 in return (at the improved price of $99.9999 per share).
  • F*TRADE pockets the $0.98 difference (in addition to all the normal trading fees).
  • F*TRADE does this 100,000,000 times per day.

If a broker doesn't run its own dark pool, then it sends the orders to the dark pool run by a larger institution (JPMorgan, Credit Suisse, Getco, Knight Capital) and gets some fraction of the dark pool's profit in return.

Are Mom and Pop negatively impacted by this? Not for most order types. They each even got a free penny out of the deal! But if there were no dark pools, that $1.00 difference between their trade prices would have gone half ($0.50) to Mom's counterparty and half ($0.50) to Pop's counterparty, who could be someone else's Mom and someone else's Pop.

So ... that's why brokers all use dark pools, and why their advertisement of their dark pool access is silly. They're basically saying, "We're going to occasionally throw you a free penny while making 49 times that much from you"!

(Note: Now apply the above math to a less liquid product than AAPL. Say, where the spread is not $0.01, but more like $0.05. Now Mom and Pop still might make a penny each, while the broker can make $4.98 on a 100 share trade!)

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