I recently opened up a discussion with readers and wanted to figure out what they want to learn more about…
The one question I kept noticing was… how do dark pools work?
Of course, I’m not going to give you a technical breakdown of they work because that involves a lot of math and computer science…
However, I will show you the purpose of dark pools… and why the “smart money” (aka the financial institutions and hedge funds) love to use these trading venues.
You see, the reason the dark pools were actually created was to cater to the elite traders.
Basically, they allowed the financial institutions to trade on “private” venues… so they wouldn’t impact the overall price and potentially hurt their entries and exits.
So how do dark pools work these days?
The Inner Workings Of Dark Pools
Now, dark pools are considered alternative trading systems (ATS) that allow participants to place orders without publicly displaying information.
You see, unlike traditional exchanges where the bid-ask prices are typically posted for market participants to see… dark pools don’t let us really see that.
If you think about it, this is actually advantageous for financial institutions.
Well, think about it like this… the traders and investors at hedge funds, investment banks, and other professional trading shops can throw down millions of dollars behind trades at times.
If one of their orders goes to a traditional exchange — a lit exchange, such as NYSE, Nasdaq, or other electronic communications networks (ECNs) — then it can impact the price of the stock or ETF they’re trying to buy or sell.
That’s the reason I believe the dark pools were created.
Think about it like this, if a trader wants to sell 1M shares of a specific stock and enter a limit order to sell on NYSE, the supply could actually drive the share price down and actually hurt investors and traders.
However, if they place the trade in a dark pool, it’s “hidden” from the public market, and it may not impact the price. In theory, that would minimize the market impact.
By creating dark pools, I think this effectively created a backdoor for the “smart money”.
Now, these traders could execute their orders covertly… and if you know anything about the “smart money” they have an edge over the mom and pop traders.
That’s why I love to follow dark pool activity.
I know what you’re thinking… “Ben, didn’t you just say this is hidden from the public?”
Well, it is…
However, when the trades are executed, they actually get reported and show up on a proprietary scanner that I use.
How I Follow Dark Pool Activity
Now, with the scanner I use, it lets me know how many shares were executed in a specific trade. If it looks interesting, I’ll conduct my due diligence and potentially make a move.
For example, a few weeks ago, I actually spotted dark pool activity in GrubHub (GRUB) on May 8.
More specifically, I noticed some block trades go off in GRUB on Friday that amounted to about $41.6M (a whopping 903,940 shares went off).
What was so interesting about this trade was someone came in at 10:24 AM that day and purchased a 602K share block at $45.72. Thereafter, I noticed another 150K block at $46.29… then another 151,400 share block at $46.825 (after the market closed!) on that Friday.
Guess what happened a few days later…
Did someone know about this information ahead of time, or was their timing just impeccable?
Chart Courtesy Of StockCharts
Who knows… but I do want to continue following the dark pool activity because I do believe it can provide me with an edge in the market.
I believe the dark pool activity may have signaled the potential pop in GRUB.
Stay tuned… because I plan on giving out some free trade ideas soon.