Commentary: When Hidden Orders Come to Light

The news on Pipeline Trading Systems’ $1 Million dollar SEC fine for trading with an undisclosed affiliated entity brings to light some very important questions about trading in so-called dark venues, and how best to go about selecting which is best for your specific investment strategy. 

Is trading in the dark really dark?  Better yet, does your order remain hidden and at what point is it not?  After your order has been executed, those fill reports, and most importantly, the partial fills can reveal quite a bit to lurking information seekers.

So let’s focus on what you must know prior to selecting a dark pool or an algo that goes to various dark pools. A dark pool is dark, until it’s not, which is true but admittedly sounds Yogi Berra-esque.  First off, a broker dark pool is a type of ATS—an alternative trading system managed by that broker-dealer.  Enter you block order and it may get matched against all of its internal flow first and/or may hit other resting blocks—no mystery there.

This is a very good thing for the fund if the order gets completed where the trader expects, and it is most definitely profitable to the owner of the pool, as the firm is capturing commissions on the buy and sell cross.  That’s why there is a growing segment of independent dark pools as well that solely match external flow.  There are over 40 dark pools for you to choose from, and as many factors for you to consider in selecting them. Europe is exceedingly close behind in new dark pool creation (review the MiFID II rule proposals on participation), and Canada with its five-plus pools today is only expected to grow.

So it’s important to know ‘what happens if’ there is no other side to your dark order, or in at least one of the dark algo’s member pools to complete your order.  If they do not offer the ability to restrict ‘routing out’ of the  un-matched part of your order, it very well may be passed through and out to an ELP—an external liquidity provider, and into, you guessed it, the light.  Now you’re in for a treat because those info gathering strategies you’ve heard about have now got you (or will in milliseconds).  Once this happens you have lost whatever impact control the dark venues were supposed to afford you through the lifetime of the balance of your order wherever parts of it may still reside. The adverse impact of which can be to the implicit costs of increased slippage and/or a costly missed alpha opportunity due to decreased execution size.

Dark venues have a reputation for lower toxicity – that is minimal information leakage and lower slippage; those that aggregate liquidity at a point in time will tend to facilitate larger prints; those which you as a buyside or sellside trader can interact with directly may improve print size as well. This information, which is a fraction of the story, only furthers the necessity of understanding the ‘which’ ‘why’ and ‘when’  you are selecting a direct path or an algorithmic path with its own hierarchy. So don’t be afraid to ask your broker who they use, how they access liquidity, and why they have selected those particular pools.

The next item to take into account is the type of flow that these dark venues accept:  order size limitations i.e. those that allow HFT (deemed ‘predatory’ liquidity), the parameters you can place on your order (price, execution size, time) and how they manage un-matched flow.  Those that allow HFT for instance may have to do with the illusion of additional liquidity in that pool that systematic HFT flow adds, and the latter, the routing out of unmatched flow, can hinder adequate execution due to the information leakage discussed earlier.

I am sure you noticed that I did not reflect on dark pool order type.  Here you must rely on your usual market savvy.  Aggressive, passive, minimum quantity – all are fine when used as needed per situation.  I am also sure that you noticed that I didn’t cover all the intricacies of each dark venue type.  My point is that these tools were created by intelligent people with an understanding of efficient order matching and commission capture. It’s up to you to understand their model and use them appropriately.

Just remember that you must shine a lot of light on the dark pool before you jump in.

Garrett Nenner is a managing director and head of global markets and a market structure specialist at Momentum Trading Partners LLC in New York.

The views represented in this commentary are those of its author and do not reflect the opinion of Traders Magazine or its staff. Traders Magazine welcomes reader feedback on this column and on all issues relevant to the institutional trading community. Please send your comments to