High-Frequency, Dark-Pool Trading Growing in Popularity

The Washington Times (Washington, DC), November 13, 2009 | Go to article overview

High-Frequency, Dark-Pool Trading Growing in Popularity


Byline: Chris Versace, SPECIAL TO THE WASHINGTON TIMES

Over the past few months there has been some concern in the markets, not just about the sustainability and volatility associated with its powerful increase in recent months, but also about who is doing all this trading. Normally, investor ownership data are filed with the Securities and Exchange Commission on a lagged basis in the form of 13D filings, which is a notification that an investor holds more than 5 percent of any class of a company's shares. Ownership and trading, however, are two different things. As such, there has been growing interest about dark-pool trading and high-frequency trading.

I recently spoke with Bernie McSherry, a senior vice president of strategic initiatives at Cuttone & Co., where he is a member of the management committee involved with strategic planning and market strategy. He has served in a number of leadership positions within the industry and has chaired several New York Stock Exchange committees and served as the NYSE governor for six terms.

Question: Bernie, in simple terms what are dark pool trading and high-frequency trading, how long have they been around and what do they mean for the market?

Answer: In 2005, the SEC issued Regulation NMS, which mandated revolutionary changes in stock market structure and effectively forced manual exchanges such as the New York Stock Exchange to permit direct electronic access to the point of sale. As a result, the markets have become fragmented and traditional stock markets have seen a dramatic decline in their share of trading due to the proliferation of dark pools and computerized trading strategies.

Dark pools are alternative trading systems in which participants execute orders anonymously without public price disclosure until well after the trade has been consummated. Large institutions such as mutual funds and hedge funds prefer to mask their trading patterns from outside view and, as a result, they are increasingly turning to dark pools as replacements for traditional stock exchanges. There are concerns that the proliferation of dark pools has fragmented the market and has led to less-efficient pricing.

Many firms use high-frequency trading to exploit minute shifts in stock prices by using automated programs to repeatedly trade retail-size orders through ultra-high-speed data lines. Those strategies have become so popular that they are currently estimated to account for more than 70 percent of all U.S. trading volume. Unlike traditional shareholders, the average life of stock ownership by high-frequency traders is typically measured in seconds and there are indications that long-term investors are being disadvantaged as high-frequency traders employ strategies that are divorced from estimates of underlying corporate valuation. …

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