Monday, July 21, 2008
dark pool trading
there's a great deal said about the "enabling myth" of the free market, but anyone being honest with themselves must say that markets are not merely regulatory constructs -- though they are certainly that, an artifice created of regulators which could not exist without regulation -- but also historically very anti-individualist. capital markets on the largest scale work through and for cliques of firms which at best seek to exploit, at worst destroy those outside the clique. the advent of widespread individual small-scale trading is a very recent democratizing development in the capital marketplace.
many would also say, as a matter of orthodoxy no less religious than that of the "free" market, that it is impossible to "beat the market". but a more circumspect and pragmatic view must again concede that reasonably well-informed small traders can and do exploit the marketplace inefficiencies of large traders. the intentions behind large capital movements often become plain before the migration of capital can be completed. this allows the adroit to hitch a ride, as it were, on price-moving capital flows. a theoretical impossibility by the queer religion of efficient markets, this is a dynamic that i often am privileged to see in action. and as the analytical firepower of these traders -- the lampreys on the belly of the fish -- grows, their capacity to take potential profits out of large traders' movements also grows.
large trading -- in response to both this phenomena and the annoying perception of it, i'm not sure which to the greater extent -- has been migrating off public exchanges for some time. the very new (in historical terms) derivative trading has been the leader in this structural change -- the entire credit default swap market, for example, is transacted over-the-counter between private parties. this of course has become a source of great concern as it has become apparent that CDS outstanding represent gross leverage of spectacular dimensions. calls to move CDS to exchange trading have grown louder.
but large equity trading will not be dragged back into high-disclosure public markets easily. and today the financial times discusses the desire of several financial institutions to bolster dark pool trading.
this bears watching, as the obfuscation of large trading will change the dynamic of the marketplace for small analytical traders. being unable to see capital flows will reduce visibility and opportunity, and likely more often wrong-foot traders as to the intentions of capital.