Dark pools now handle roughly 12.6% of all trading in stocks in the United States, by the monthly account of Rosenblatt Securities, an agency brokerage.

Roughly a billion shares every day change hands in these venues, where the identities of participants are kept anonymous.

The anonymity is designed to protect mutual funds and other holders of large positions in stocks. These can be traded in large blocks-often as large as 50,000 or greater-in block-focused dark pools like Liquidnet and Pipeline, or in smaller, "child order" increments in dark pools offered by many other brokers.

But unless they demand to know, fund managers themselves typically can be kept in the dark about where their trades are being executed and how the venues that are chosen stack up against those not used by the brokers involved.

So here's the four-step process recommended by Alison Crosthwait, director of global trading research at electronic trading specialist Instinet, on how to achieve see clearly see what's happening with your trades, when they are being executed in dark pools.



Ask each broker what dark pools they are connecting with, when executing trades. Require each to provide an explicit list of the dark pools they are connected to, as well as to update you an update, any time they connect with a new dark pool or drop access to another. Maintain a list, electronically, of all venues accessed by each broker. Check it monthly, whether you got updates in the intervening time or not.

Compare these lists and asks brokers who are not connected to certain pools to justify their decision.



Require each broker to send you an end of day file-sometimes called a "destination report"-that details every dark pool transaction executed on your behalf. This report should include execution venue, stock, order size, number of shares bought or sold, price and time. This will give you a raw sense of where your orders are being placed and where your brokers are finding liquidity. "So you get a sense of what's going on," Crosthwait says.



You can easily see from the destination report which venues each broker relies upon most heavily to execute trades. While there are over 40 dark pools in the US alone, the majority of volume is traded in the largest four or five pools.

But being the largest doesn't necessarily mean that those pools provide the highest quality trade execution, and a destination report will help analyze the pools in which "adverse selection'' is minimized. Adverse selection, sometimes also referred to as "market impact," refers to a situation where the act of trading causes the stock price move away from the trader.



Over time, analysis of destination reports should provide greater clarity as to which venues are most reliable and where adverse selection is minimized. But simply knowing is not enough. Your trading desk must ensure that the brokers they are using are acting in your best interest and are utilizing the most appropriate dark pools. And making constantly making adjustments based on this knowledge will make a difference in terms of generating better than average returns. "This will ultimately help make fund managers more competitive," said Crosthwait.

Wading into the uncertainty of dark pools is "relatively new" to fund managers, Crosthwait says.

But, if you're going to swim there regularly, it's unavoidable.



Crossing Instinet Instinet nearly 25 years ago created the first crossing network, matching buy and sell orders in equities electronically without first routing them to an exchange or other displayed market.

That network, called Last Daily Cross or LDX, was launched on Dec. 16, 1986.

Last year, Instinet began using its largest dark pool, CBX, to help mutual funds and other clients buy or sell large options contracts in the United States.

CBX crosses shares continuously in stocks (and exchange-traded funds).

LDX crosses buyers and sellers at a specific point in time.

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