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- Herausgeber: GRIN Verlag
- Sprache: Englisch
Diploma Thesis from the year 2012 in the subject Business economics - Banking, Stock Exchanges, Insurance, Accounting, grade: 3,0, Hamburg University of Applied Sciences, course: International Finance, language: English, abstract: This paper examines the characteristics of equity trading and especially two relatively new phenomenons which are dark pools and flash trading. Over the last years these two terms became more and more important in equity trading and today they are a real alternative to traditional exchanges, like the New York Stock Exchange or Deutsche Börse. But these new evolutions do not only have advantages. Indeed there are concerns that beside the benefits, like fast execution times, sophisticated techniques and less market impact, these mechanisms can also burrow risks. These risks are difficult to estimate, with an evolution of these new platforms that was so quick, that one might have the impression that even regulators do not full yet understand what might happen in the case of a next financial crisis. However with a market share of 15%-20% of all trading activity in global equities and a jump of almost fivefold in the period of time from January to October 2009, these new mechanisms cannot be ignored anymore. Therefore this paper explains in detail the functionality of dark pools and other current trading strategies. All important factors like different market structures, market liquidity aspects, as well as regulatory framework and technology facets will be reviewed. Further an outlook should be given to the reader on how the evolution of dark pools & co. might continue in the coming years. With dark pools and flash trading, trading is now dominated by rapid-fire computer systems that might create a more technically driven market, rather than one based on fundamental forces. It remains to see whether this evolution will continue.
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Veröffentlichungsjahr: 2014
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Contents
List of Figures
List of Tables
List of Abbreviations
1. Introduction
2. Equity Trading and its new phenomenons – Definitions and Characteristics
2.1 What is Equity Trading?
2.2 Dark Pools – Definition
2.3 Dark Pools – Rationale
2.4 The Trading Framework
2.4.1 Pre-trade phase
2.4.2 Trade phase
2.4.3 Post-trade phase
2.5 Orders
2.5.1 Market Orders
2.5.2 Limit Orders
2.5.3 Peg Orders
2.5.4 Hybrid and Complex Orders
2.5.5 Order Parameters
3. Different types of Market Structures and Market Liquidity
3.1 Physical and electronic markets
3.2 Continuous Markets
3.3 Quote-driven and order-driven markets
3.4 Displayed and nondisplayed markets
3.5 Market Liquidity
3.5.1 Block liquidity
3.5.2 Supply and demand for liquidity
4. Pricing in the dark pool sector
4.1 Price discovery
4.2 Price derivation
5. Regulatory Framework and Control in Europe
5.1 Regulatory Framework in Europe - MiFID
5.2 Financial Regulation and Dark Pools
5.3 Reporting and transparency
6. The structure of dark pools
6.1 Exchange orders and brokers as sources of dark liquidity
6.2 Multilateral Trading Facilities (MTFs) as sources of dark liquidity
6.2.1 Electronic limit order books
6.2.2 Crossing Networks/Price Reference Systems
6.3 Broker desks as sources of dark liquidity
6.4 Direct market access (DMA) as source of dark liquidity
6.5 Hybrid business models as sources of dark liquidity
6.6 Market overview
6.7 Dark sector evolution
7. Trading in the dark
7.1 Execution issues
7.2 Trading Strategies
7.2.1 Block Trading
7.2.2 Program Trading
7.2.3 Algorithms and Algorithmic Trading
7.2.4 High Frequency Trading
7.2.5 Gaming
7.3 Aspects of Technology
7.3.1 Order Management Systems and Execution Management Systems
7.3.2 Routing Engines
7.3.3 Matching and Pricing Engine
7.3.4 The FIX Protocol
8. Conclusion – The future of dark pools and flash trading
List of References
List of Figures
Figure 1: Market Clearing Price
Figure 2: Daily market share equities (FT, Trading Room, 2012)
Figure 3: The Thirty-Millisecond Advantage, “The New York Times”, 23.07.2009
Figure 4: Broadcom’s Performance on the 15th July 2009, FAZ, 06.08.2009
List of Tables
Table 1: Fidessa Fragmentation Index, report for week ending 27th July 2012, Fidessa Group plc.
List of Abbreviations
1. Introduction
The history of equity trading began hundreds of years ago, when the first companies needed money for their projects and asked private investors instead of banks for equity. Later, in 1969, when the first electronic stock trading was introduced in the U.S., namely Instinet or Institutional Networks, trading became electronic. Shortly thereafter, in 1971, the first fully automated exchange, the so called NASDAQ (National Association of Securities Dealers Automated Quotations), was created. The NYSE, which was founded as a physical, order-driven, auction-based market, entered the electronic sphere in the early 1970s. In 1977 the first electronic trading montage screen, showing quotes on NYSE stocks, went live through Instinet’s efforts. Another pioneering platform was Investment Technology Group’s (ITG) POSIT (Portfolio System for Institutional Trading), which was introduced in the late 1970s. POSIT was already crossing block trades electronically away from the exchanges on a scheduled basis (Domowitz et al, 2008: 1).
From 1980 on brokers started to use their own electronic proprietary trading systems to cross trades for clients. Further pioneering move was the introduction of the first after-hours crossing platform in 1986 by Instinet. In Europe it was the Paris Bourse (today part of NYSE Euronext), which developed a leading edge electronic trading platform for the French stock market as early as 1989. Although electronic trading developed during the late 1980s and early 1990s, it was only in the late 1990s and beginning of the 21st century that technology, communications and networking reached a state that ATSs became useable (ibid).
Although the concept of hiding is not a new concept, as it has been around for several years, in the form of hidden orders, the dark pool phenomenon and crossing network structure came into focus only in 2002, when the INET, a product of a merger between the Island ECN and Instinet, announced that it would stop displaying order book limit prices to avoid connecting to the relatively slow Intermarket Trading System (ITS). With this action INET effectively “went dark”, as limit orders were no longer visible to market participants. A formal dark pool platform, Instinet CBX, followed in 2003 (Domowitz et al, 2008: 1).
While in 2003, 7 crossing networks has been established as providers of nondisplayed liquidity, only 5 years later their number had surpassed 40. Although estimations about the current dark volumes are not easy, as these volumes appear mixed with all OTC trades, it can be assumed that approximately 15 % of all traded volume in the U.S. and about 10 % of all European trades are executed in the dark. With this fast growth, in only one decade, electronic trading and especially dark trading became a very important market mechanism. This becomes even more apparent when looking at the projections which suggest that at least half of European and U.S. markets will trade in the dark within the next 5 years (Grant, 16.12.2009).
This paper is supposed to give the reader a better understanding of equity trading in general, with a focus on new trading phenomenon’s, namely dark pools and flash trading. It provides a definition of equity trading in general and dark pools in special in chapter 2 where these terms as well as other trading related terms are explained and an overview of the trading framework is given. Moreover the most important types of orders and order parameters are explained to the reader.
In order to better understand the concept of the new mechanisms, chapter 3 gives an overview of the different types of market structures and explains the importance of market liquidity. The chapter is concluded with a differentiation between liquidity suppliers and liquidity demanders.
In chapter 4 the pricing in the dark pool sector is explained. The importance of price discovery and price derivation is highlighted.
Chapter 5 deals with the important topic of regulation and control. Due to the multiplicity of different national regulations, the paper focuses only on the European regulatory framework, which is MiFID.
Finally in chapter 6 the structure of dark pools is explained. All different sources of dark liquidity are highlighted and a market overview of the dark sector is given. The chapter is concluded with a regard on the dark sector evolution. Chapter 7 continues with the dark pool sector and focuses on the different trading strategies in this sector. In addition the technological aspects of dark trading are explained in non-technical terms.
Chapter 8 will summarize all the important information about dark pools and flash trading.
2. Equity Trading and its new phenomenons – Definitions and Characteristics
In the following chapter a basis about equity trading and dark pools should be given to the reader. The most important terms will be explained and an overview of the trading phases and the different types of orders and order parameters will be given.
2.1 What is Equity Trading?
In general equity trading can be described as the buying and selling of securities, which can take place on a regulated market, for instance at one of the major stock exchanges like the New York Stock Exchange (NYSE) or the London Stock Exchange (LSE), or off-exchange, bilaterally, on the so-called Over-The-Counter (OTC) markets.
