Institutional Investor's Alpha Magazine - July/August 2008 - (Page 55)

Dark Pools that neither his name nor his ﬁrm’s be used, says he goes to Liquidnet for big block trades but also routes trades to more than a dozen other dark pools through his order management system. His daily hunt for liquidity requires constant monitoring. “On any given day it varies dramatically which dark pool is the best,” he says. One of the newest systems that aggregates dark pools is OnePipe, a joint project of Weeden & Co. of Greenwich, Connecticut, and New York–based Pragma Financial Systems. Launched earlier this year, OnePipe acts as an electronic agent that plumbs 31 dark pools, using software that is promoted as being smart enough to know the best sources of dark liquidity at any moment. “We make it possible to expose yourself to maximum liquidity,” says Peter Fraenkel, director of quantitative services at Pragma. “It is pretty much impossible to duplicate this on one’s own.” But even with OnePipe there remains the question of whether the right pools are being tapped. Liquidnet, for example, doesn’t allow outside connections, so OnePipe starts out without a link to the pool with the biggest transactions. (OnePipe does connect to H2O.) For active traders the array of dark pool sites also means coordinating several different routing tools to ﬁ ll orders. Drina Loncar, a senior trader at Pentwater Capital Management, a Chicago-based hedge fund, accesses several prime broker dark pools as well as OnePipe. “You have to be where the liquidity is,” notes Loncar, whose ﬁrm manages $1.25 billion. Rosenblatt’s Gawronski says one way to monitor a dark pool router is to measure which pools end up with your orders most often. If the router is supposed to access 20 pools but almost all of your orders wind up in the same one or two, it’s a good idea to ﬁnd out why, particularly if your trades are being consistently routed to the pools that charge your provider the lowest fees. One issue that faces all dark pool users is information leakage. “If you are putting orders in 30 dark pools, can you imagine the possible information leakage you are causing?” says Rishi Nangalia, who manages Goldman, Sachs & Co.’s global electronic trading business. Dark pool quality is more important than quantity, he adds. If a sly trader can discover a dark pool block trade before it gets consummated, particularly if the stock is thinly traded, then the game is on. Using small trades in the public market, the gamer can move the stock price up or down, then jump back into the pool to take advantage of the price change by executing against the block trader. The most common strategy to set up the sting is to “ping” dark pools by sending a small order for, say, 100 shares of a stock to see if any nibbles come back. “I know there are people who use computer programs to try to game pools,” says the hedge fund trader who asked not to be identiﬁed. “I analyze it quite a lot and tend to route to places where I know there is more policing going on.” Dark pool operators and service providers now tout their antigaming strategies in their marketing. OnePipe’s software includes antigaming logic that hunts for various types of price manipulation. Pool operators have rules that ban gaming and banish suspected violators. Pentwater Capital’s Loncar isn’t convinced that the antigaming tactics offer effective protection. She considers her own diligence and constant review of her dark pool trading as her last defense. “I don’t think antigaming is very good, frankly,” Loncar says. “What you have to do is manage your orders. If you don’t look after [them], somebody else may get the better of you.” Gamers are not the only hazard dark pool traders need to watch for. Because pools are sought as sources of liquidity, it is important to know how much trading takes place in them. But they are notorious for fudging their numbers by counting both sides of a trade. Andrew Silverman, coleader of electronic trading at Morgan Stanley, has been making the rounds of investment seminars lately, telling traders that estimates of dark pool volume — which have been pegged at as much as 20 percent of all stocks traded — are highly suspect. He says the pools account for no more than 9 percent of trading volume, and could be considerably less. — LARRY TABB, CEO, Morgan Stanley, like several TABB GROUP brokerage houses, offers its own dark pool and also routes to ten others, including those of competitors UBS and Goldman Sachs, as part of a new dark pool alliance among the three ﬁrms. Silverman says that because most of the volume can be found in the top ten pools, traders don’t need access to dozens. Extra routing just leaves more footprints, he adds. Larry Tabb, founder and CEO of research at consulting ﬁrm TABB Group, believes there may be some value in extending past the top ten pools, especially when dealing in thinly traded stocks. Technology has made shopping a large number of dark pools not only possible but extremely fast. “You can go blast out to 20 dark pools and see if there is liquidity in ﬁve milliseconds,” he says. But though the execution may be fast, the technology is not necessarily easy to use. Craig Viani, head of electronic trading at BNY ConvergEx Group, says the range of dark pool options is part of a dizzying array of electronic possibilities confronting today’s trader. ConvergEx, which is partly owned by Bank of New York Mellon, tries to cut through the complexity with a smart router that looks for liquidity in dark pools and more traditional markets. The bottom line is that dark pools offer some advantages to traders, but knowing which ones to use and how to access them requires work. “It is the obligation of the hedge fund trader to know what he is using and how he is using it,” Gawronski says. “You can go blast out to 20 dark pools and see if there’s liquidity in ﬁve milliseconds.” JULY/AUGUST 2008 • INSTITUTIONAL INVESTOR’S ALPHA • 55

Table of Contents Feed for the Digital Edition of Institutional Investor's Alpha Magazine - July/August 2008

Institutional Investor's Alpha Magazine - July/August 2008 Contents Letter from the Editor Longs & Shorts Pension Corner: Mr. Big Goes Small The Good Guys: Adopt This School! Interview: Man's Great Hope Cover Story: The Gentleman Activist Strategies: The New Bankers Profile: Staying Alive Research Center: The Best of the East The Asian Sensations Alpha Bytes: Into the Light Unhedged: Commentary: Speculating on Washington

Institutional Investor's Alpha Magazine - July/August 2008

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