Computation finance - Essay Example

Creation of these dark pools has been possible because of existence of electronic trading and the fragmentation of avenues of conducting financial trading. The participants access them directly amongst themselves or through crossing networks. Dark pools are made up of three types, including where the independent entities create a distinctive and differentiated means of trading, those that are owned by brokers allowing the clients of the broker to trade amongst themselves in anonymity, and those created by the public exchanges themselves, meant to give their customers a chance to enjoy trading in anonymity and hiding of orders while trading.

Hidden liquidity allows traders to ‘hide’ all or a part of their orders, which results into a market with two components – a displayed component and a non-displayed component. Hiding of orders, however, makes market participants to access incomplete knowledge regarding the market’s general depth. This paper is going to look at how these dark pools of liquidity work, why they are needed and their impact on the visible market. Most of the electronic exchanges that are order-driven use specific order types to provide liquidity such as what is referred to as ‘Iceberg Order’.

An Iceberg Order is a passive order that is split into small portions, with partly or none of which is visible to the public. By concealing the actual quantity of the order, it is possible to tame price movements and reduce leakage of information, as well as any other flows that culminate from significant adjustments in the supply of stocks – this is called market impact. Splitting of orders is automated through order management systems, and it is a standard strategy used by many institutional investors.

1 2 Companies are allowed to choose from three types of dark pools. The first include those owned by broker