bell of the New York Stock Exchange After the closing bell rings, whether it's the physical bell of the New York Stock Exchange or the virtual bell of the Nasdaq, you may believe that trading activity has ceased for the day and the shares of the companies you trade in are sitting quietly until the markets open again the following day. That's not necessarily true.

Behind the scenes, your companies may be seeing trading action in so-called "dark pools," secondary stock markets that operate out of sight of the average investor and beyond the reach of regulators.

The Yin and Yang of Trading

In financial jargon, "dark" is the opposite of "displayed." Displayed pools are regulated, public stock exchanges, examples of which include the NYSE and the Nasdaq. In a displayed pool, anyone who wants to buy or sell a particular equity has an equal view of all the activity going on with that company's available shares, including the volume being traded.

Dark pools are private exchanges that are used by institutional investors. In dark pools, brokers are typically trading large numbers of companies' shares, shares the average investor has no access to. Private operators of dark pools include Liquidnet and Pipeline, as well as broker-run operations like Credit Suisse's (CS) CrossFinder and Goldman Sachs' (GS) Sigma X.

Why trade in dark pools at all? If an institutional investor tried to move a large block of a company's shares on a traditional public exchange, that investor would likely find that the large volume moved the market, with a resulting price distortion. By trading in dark pools, institutional investors can trade at the enormous volumes they need to without automatically putting themselves at a disadvantage.

The People's Market

According to Financial Times, there are about 50 dark pools operating in the U.S. Counting the big broker-run operations, the newspaper estimates that nearly 40% of equity trading volume now occurs outside the traditional stock markets and in these dark pools. That's a lot of trading being done outside the view of the average investor.

The stock market has its origins as a people's market, a way for middle-class citizens to get a share in the world's burgeoning commercial activity beyond what they did to earn a living. The Dutch East India Company was famous for being one of the first public companies to let anyone off the street buy a share.

But maybe more important, the stock market has been the primary capital creator for companies in the U.S. as well as the U.K. While German companies were more likely to turn to the banks for funding, and Japanese companies bought large blocks of stock in one another's companies to support growth, in America and Britain, companies rose on their ability to attract a larger volume of small investors.

Keep Investors Invested in the System

Dark pools are an invention of the marketplace, and serve a purpose. For big investors that need to move enormous numbers of shares around, dark pools offer a more level playing field. From the individual investor's perspective, one could argue that keeping these big trades off the public exchanges is also useful because of the price distortions they can inflict.

And for any commodity, there have always been wholesale and retail markets. Buyers and sellers who can deal in large quantities have always had pricing advantages over the average end-of-the-line consumer.

But just as an income gap can get so wide that those at the bottom lose faith in the system and stop participating in it, or worse, start to work against it, the perception of an overly tilted playing field on the trading floor can cause the average investor to lose faith in the equities market. And that trust is something regulators should look to preserve. Millions of nest eggs and college funds depend on it, as well as all the companies and jobs that nest-building creates.

John Grgurich is a regular contributor to The Motley Fool, and owns no shares of any of the companies mentioned in this column. Motley Fool newsletter services have recommended buying shares of Goldman Sachs.


Increase your money and finance knowledge from home

Professional Vs Do it Yourself Investing

Should you get advice or DYI?

View Course »

Investing in Emerging Markets

Learn to invest in a globalized world.

View Course »

Add a Comment

*0 / 3000 Character Maximum

66 Comments

Filter by:
A. Richoux

Dark pools are useful because because they avoid distortions that large trades can inflict???

The only way we have to judge value is supply and demand. If information is hidden from us the individual investor can make rational decisions. This in not providing a "level playing field" for the institutional. If they want to sell or more than existing supply, they need to raise(or lower) their price to bring in new supply.

February 24 2013 at 7:29 PM Report abuse rate up rate down Reply
fmeyer11

More paranoia than reality in this article.

July 10 2012 at 10:45 PM Report abuse -1 rate up rate down Reply
kafienkarl

Some people want to strictly blame government for absolutely everything. Don't forget and maybe even more powerful are the banks, Wall Street and London. The derivative market is a multi trillion dollar market. It's a casino. Trades are made in the dark with little to no transparency. This is how the financial people or the "banksters" seperate people, organizations and countries from their money. They had almost everything do with the mortgage crisis and now manipulating the LIBOR. I encourage people to look beyond just government officials. The financial elite run this country and many others.

July 10 2012 at 10:36 PM Report abuse rate up rate down Reply
joejoegolfn

I Don't invest in the stock market and never will. I have never lost money in my investment and have averaged over 6 percent a year for 42 years. I could never figure out what value to a company was added by buying and selling it stock. A lot of people get rich buying and selling stock but add nothing to the bottom line.

July 10 2012 at 7:18 PM Report abuse rate up rate down Reply
1 reply to joejoegolfn's comment
ME

In theory, the equity made by selling off a portion of your company allow you to invest in resouces that you could not afford by yourself. This rarely happens anymore.

July 10 2012 at 8:24 PM Report abuse rate up rate down Reply
oldtooly

The stock market is no place for the "non-interested". The days of buying stocks and then coming back years later to reap your rewards are over. You have to manage them frequently, whether that means becoming a day trader , or paying a legitimate money manager. Everyone I know that leaves their investments alone in say a 401K plan, periodically gives most or all their gains back in some sort of correction. Then we hear, Oh it will come back. And it does, but during that return period they are only playing catch up. And of course some lose a ton and never make it back. But few people who do not actively manage their stocks and other investments ever make out on top. Personally I find money management as exciting as watch grass grow so I settle for mediocre returns by mediocre management firms who charge very little and stay , for the most part, on the safer side of investing.

July 10 2012 at 7:10 PM Report abuse rate up rate down Reply
mizsong

One of the biggest dark markets are the oil speculators. That's why the price at the pump goes up and up and has nothing to do with supply and demand. This is well known and documented and nobody on K street or Wall street wants to touch it. Too many hands in too many pockets.

July 10 2012 at 6:58 PM Report abuse rate up rate down Reply
Frederick

Do not this article fool or scare you, it's been happening for years. It's another way for Motley Fool to get you to buy their newsletters. Yet, they are correct, handling your own investments is way better but yopu need objective information & a bit of Investment knowledge. Why pay a "pro" to 1.25% or more when you can that $ and learn how to do your own portfolio.

July 10 2012 at 6:37 PM Report abuse rate up rate down Reply
1 reply to Frederick's comment
jdykbpl45

Motly fool writes for the village idiots.

July 11 2012 at 9:44 AM Report abuse +1 rate up rate down Reply
Scott

I liked the #1 Dad in the picture in which has the name "Rich". The photographer did a good job and perhaps the editor even more so. How many noticed until it was mentioned ? Or did and now thought more about it? Just curious as it was the closets point of the photo in how it was shown to make a point.

July 10 2012 at 6:36 PM Report abuse rate up rate down Reply
Wayne Gage

So what. Nobody is hurt by this "unlawful" trading. There is no scam and no victims.

July 10 2012 at 6:03 PM Report abuse -6 rate up rate down Reply
1 reply to Wayne Gage's comment
mlanzi300

I see you are a person that benefits from this arrangement

July 10 2012 at 7:55 PM Report abuse +1 rate up rate down Reply
delcoguy50

The foxes have the run of the hen house, been that way for a while

July 10 2012 at 5:50 PM Report abuse +2 rate up rate down Reply