Dark Pools – Shrouded Exchanges

Katherine Doherty of Bloomberg recently wrote a wonderful and yet frightening article titled, "Wall Street Enters Darker Age with Most Stock Trading Hidden" (1)

Here are the first few paragraphs of the article……. "Here's a surprising new fact about the world's largest and most-liquid public equity market: Most of the activity on it isn't public anymore.

For the first time on record, the majority of all trading in US stocks is now consistently occurring outside the country's exchanges, according to data compiled by Bloomberg.

This off-exchange activity — which happens internally at major firms or on alternative platforms known as dark pools — is on course to account for a record 51.8% of traded volume in January. Barring an unexpected dip, it will be the fifth monthly record in a row, and the third month running that hidden trades make up more than half of all volume."

My firm, LCM Capital Management, thinks this should scare anyone who buys and sells stocks, ETFs, or other securities on our exchanges and believes that they are getting the best price. I know for a fact that the "dark-web" is not a good place to be, so I cannot imagine trading in "dark pools" is good for us either, unless of course you are a large institution.

The article states that, "the number of off-exchange venues known as alternative-trading systems, or ATS, offer an alternative, anonymous way to process trades and has been growing." That does not sound very positive to us. "These ATS use different mechanisms to match buyers and sellers without the desired price being displayed on a public exchange, or automated auctions where parties express the value they are willing to buy or sell stocks for. Using off-exchange venues helps institutional investors limit information leaking to the market and adversely affecting prices." This strikes us as a polite way of saying this is being done for the betterment of the big guys at the expense of the little guys.

Joe Saluzzi of Themis Trading. said "The bigger institutions seem to have a better experience where they can command more value." Hmmm, I know myself and our clients would sure like a better experience and more value when we are buying or selling stocks, how about you?

We are a federally Registered Investment Advisor (RIA) regulated by the Securities and Exchange Commission (SEC), which is tasked with protecting investors – and to their credit, they've made efforts when it comes to the ATS. However, according to the article some of their proposals have been stymied with only a few watered-down ones passing.  This leads us to wonder if the game is rigged if our regulators can't seem to break-in.

The Head of Strategic Operations and Public Policy at NASDAQ, Chuck Mack, says, "the worry is that the move toward off-exchange could ultimately make pricing less efficient and drive-up costs for investors and issuers." I feel comfortable telling Chuck, remove the word "could" because it "will," and once again, be at the expense of the little guy.

If you have read any of our previous blogs, you know LCM Capital Management despises these firms and big institutions and why trading the market is a fool's game. We believe the system is rigged and Ms. Doherty's article is telling you as much.

So, what's an investor to do?

• Remember investing is not a game and investing is not synonymous with trading. We have just explained to you that the playing field is not level and from the looks of it, only getting worse.
  
  
• Control what you can control, namely, your fees, your investment taxes and avoid owning actively traded mutual funds (our next blog will explain to you why that is). Keep in mind, one should invest for the long-term and turn off or mute the talking heads on financial cable TV stations – they know no more than you or LCM Capital Management.
  
  
• Be skeptical of anyone promising to "beat the market" through stock picking or active trading strategies. The reality is, if the institutions with all their resources are pulling the strings behind the scenes, then the average investor has even less of a chance of consistently winning.
  
  
• Focus on strategies that do not rely on playing Wall Street's game. Broad diversification, disciplined rebalancing, and tax-efficient investing will serve you far better than trying to outmaneuver an industry that increasingly relies on shrouded exchanges.

There is a better way!