Institutional Investor's Alpha Magazine - April 2009 - (Page 28) Dark Pool Trading no information leakage other than fills; but that’s unavoidable, as inevitably when you buy or sell something, you learn that there’s someone on the other side.” Using dark aggregation algorithms While venues are often quick to establish ways in which they do not route orders because of client fears of information leakage, there’s a lot of secrecy surrounding exactly how and where they do fill orders, because this can represent a competitive advantage.That’s why there’s such an intense focus on developing better proprietary dark aggregation algorithms, which search different dark venues to get the best execution, while protecting against information leakage and predatory behavior. “The routing challenges associated with navigating a 40or 50-venue marketplace are significantly more complicated than just a few years ago, when we had four or five markets,” says Fidelity’s Brown. “We’re leveraging cuttingedge network optimization algorithms to access this growing network of liquidity.” Pragma’s Rivelli agrees that intelligent logic and technology is the solution to the challenge of market fragmentation. “It’s about doing lots of research on liquidity, anti-gaming and where the best execution lies. Firms that do that will be the beneficiaries,” he says. Because the platforms are dark and do not display quotes, dark pool routers have to make increasingly sophisticated predictions on where liquidity exists in various markets based on where orders have been executed in the past. “The challenge is to build functionality that understands where liquidity is most likely to be for a particular stock at a particular hour, and to access those multiple destinations with as little time slippage as possible in order to get the best execution,” says Fagen. He adds that the buy side is likely to use even more of these dark aggregation algorithms in the future, because of the complexity of dealing with so many platforms directly. Of course, using algorithms that predict trading patterns on the basis of past behavior is difficult when there is extremely high equity-market volatility. “If historical patterns of trading are so erratic that Despite the proliferation of DIFFERENT PLATFORMS, few market participants foresee significant CONSOLIDATION. you can’t make good determinations of what to do in the future, algorithms are less valuable, so it’s challenging. But then trading is a combative art,” says Mahoney. A combative art it may be, but despite the proliferation of different platforms, few market participants expect there will be significant consolidation, although some dark trading venues will inevitably attract more liquidity than others. “At the margin, there might be consolidation, but where we’ve seen the biggest growth is among broker-run ATS, and those are ATS that a firm like Fidelity will run simply for efficiency reasons,” says Brown. “I don’t think you’ll see a lot of consolidation among broker-dealer platforms, unless you see more of the M&A activity among broker dealers that we’ve seen in the past year.” Pragma’s Rivelli believes it can be sensible strategy for the buy side to tap a number of dark liquidity venues anyway. “Some clients will use multiple aggregators or liquidity tools,” he says. “It’s a wise decision not to put all your eggs in one basket.” He adds that the current market volatility, combined with the poor business environment for many individual broker dealers, means that it can pay to diversify away from any single brokerdealer platform.” In fact, dark pool trading looks like it will continue to grow even without consolidation, as more buy-side traders get comfortable using dark venues and establish connectivity with them. That growth will eventually be limited simply because dark pools require price discovery from the lit exchanges in order to operate. In the short term, though, more buyside traders are likely to see the value of executing trades in the dark, even as the hunt becomes more challenging. ■ “CrossFinder has no information leakage other than fills; but that’s unavoidable, as inevitably when you buy or sell something, you learn that there’s someone on the other side.” Dan Mathisson Credit Suisse 8 • Alpha Sponsored Report • April 2009
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