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September 17, 2008

A Lifeguard Against Gaming in the Dark

By James Ramage

Liquidity seekers have a new tool to help protect their positions in dark pools from gamers. Broker Weeden & Co. and software vendor Pragma Financial Systems developed OnePipe Lifeguard anti-gaming logic to ensure traders' dark orders are safe.

The problem the firms are trying to solve is an old one: an unscrupulous seller (buyer) pushes the price of a stock up (down) before depositing his order in a dark pool. The trade then goes off in the ATS at a price more to his liking. The contra side ends up paying more or receiving less.

The firms' solution is to monitor trading in the marketplace and look for such manipulative behavior. Weeden and Pragma designed Lifeguard to look for a price that has been "ratified" by healthy volume in the open market, said Peter Fraenkel, Pragma's director of quantitative services.

"And what we'd produce from that is a continually updated fair price beyond which we won't trade," Fraenkel said. "We'll set a limit-along with the orders that we send on to the crossing networks-that will effectively pull our orders out and make them un-crossable when they're beyond what we consider to be the fair price."

Lifeguard is embedded within OnePipe, the firms' dark pool network aggregation tool that resides on a buyside client's OMS. And as OnePipe is a central point through which a trader's order accesses 31 dark pools, so Lifeguard's coverage extends to shield a client's order sent to those destinations.-James Ramage

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