In the book Dark Pools: The Rise of the Machine Traders and Rigging of the US Stock Market, author Scott Patterson, who covers government regulation for the Wall Street Journal, exposes the dangerous side of markets that operate under “dimly lit” conditions.  The issue of markets facilitating large block transactions in secret has provided significant privacy benefits to participants, but are also a cause of consternation among regulators and market participants.  The dark pool stands in stark contrast to the regulated exchange, where fees, liquidity and market transactions are known to all.

Dark Pools, Meet "Twilight Pools"

A new type of trading venue is emerging called the “Twilight Pool.”  In an article on Tabb Forum, author Peter Fredriksson notes a new type of exchange where the level of opacity “is controlled to match pre-defined conditions.”

Twilight pool: Agreed upon market information given transparency

“A twilight pool is a liquidity venue that is essentially dark, but which illuminates certain elements of information regarding market activity for periods at certain times of day or under specific circumstances, generally for the purpose of attracting more liquidity at those times and matching buyers and sellers,” Fredriksson wrote.  “Think of it as speed dating for market participants, but only under semi-lit conditions.”

If market participants agreed that showing a computer heat map of where the best bids and offers existed, as opposed to calling around various trading desks, the market operator would offer this degree of agreed upon transparency.  “These heat maps can show levels of activity in the market, without necessarily giving too much information away, such as any indication of size or depth on the bid or offer,” Fredriksson noted.

The primary benefit of the twilight pool is that they serve the purpose of allowing institutional investors to shift large blocks of stocks without “showing their hand” to traders, exposing them to adverse price movements.  “This is particularly the case in less liquid products where, even if they use clever execution algorithms, those algos still leave footprints and run the risk of being identified and ‘sniffed out’ by some of the more predatory trading firms,” the report said.

The twilight pool answers many of the issues with a dark pool.  The major disadvantages of dark pools is that firms generally cannot see existing bids or offers, or event the amount of trading that is occurring.  A twilight pool, on the other hand, allows all of the anonymity of dark pools to be maintained, while illuminating aspects of the market during key periods.

“Speed dating by candlelight”

“By controlling the levels of transparency or opacity that market operators are applying to the market at any point in time and being able to focus trading activity at specific times of day, dark pools offering this kind of ‘speed dating by candlelight’ capability are attracting liquidity from previously untapped sources,” Fredriksson noted. “And in the new world of fragmented markets, the ability to attract and keep liquidity is essential for any trading venue.”

While this development is, itself, not entirely well known, the development is worth tracking.  However, like a dark pool, there isn’t much available information in public view on twilight pools at this point.