The term dark pool refers to a private forum or securities exchange used by traders. A dark pool is not accessible to the investing public, and the name describes the lack of transparency that exists in these exchanges.
Explanation
Also known as dark pools of liquidity, dark pools are oftentimes used by institutional investors looking to make large trades. While these pools can be created via contractual agreements, they can also be accessed through what are known as crossing networks.
Dark pool participants do not disclose their trades on an order book that is visible to the exchange prior to execution. The lack of transparency with respect to the value these institutional investors place on the securities they are looking to buy or sell allows them to avoid the possibility of moving the market in a manner that is adverse to their position. That is to say, the lack of transparency is thought to provide them the opportunity to obtain the best possible price on the securities they're trading. Unfortunately, this same lack of transparency can make them targets of predatory trading practices. Generally, there are three forms of dark pools:
Public exchanges can facilitate the non-displaying of orders using their existing exchange network, while providing these larger clients with anonymity.
Traditional brokers that facilitate anonymous trades between their clients.
Independent organizations established for the sole purpose of offering their clients a segregated platform for trading.
The term market peg order refers to those that follow the best bid, when selling a security, and the best offer, when buying a security. Market peg orders follow the opposite side of the market than primary peg orders.
The term National Best Offer refers to the lowest available ask price, which is a consolidated value from all of the national stock exchanges. The National Best Offer is the lowest price sellers are willing to accept for a security such as a stock.
The term National Best Bid refers to the highest available bid price, which is a consolidated value from all of the national stock exchanges. The National Best Bid is the maximum price buyers are willing to pay for a security such as a stock.
The term market order refers to instructions sent to a broker to buy or sell a security immediately at the best available price. Since there are no restrictions on the selling or purchase price of the security, a market order is oftentimes immediately executed.
The term limit order refers to instructions sent to a broker to buy or sell securities at a specific price or better. Since a limit order is not a market order, there is no guarantee the transaction will occur.
The term day order refers to broker instructions to buy or sell a security that automatically expires at the end of the trading day if not executed. Unless specified by the investor, the default orders to buy and sell stocks at most brokerage houses are day orders.
The term primary peg order refers to those that follow the best bid, when buying a security, and the best offer, when selling a security. Primary peg orders allow traders to get the best possible price as a security moves within certain boundaries.
The term long position refers to the practice of buying a security with the expectation that its value will increase over time. Long positions apply to stocks, commodities, currency as well as options.
The term alligator spread is used to describe a combination of puts and calls that are not profitable due to relatively high commissions. Alligator spread refers to the investor's position being "eaten alive" by the commissions.
The term discretionary order refers to instructions sent to a broker that provides latitude to determine the best price for a transaction. In some markets, discretionary orders allow traders to provide and take liquidity using a single order.
The term Do Not Reduce refers to broker instructions to not lower the price of an order by the amount of an ordinary cash dividend on the ex-dividend date. Do Not Reduce orders typically apply when the price on an order is under market, and accompanied by Good-Til-Canceled instructions.
The term midpoint peg order refers to those that are aligned with the average of the National Best Bid and National Best Offer. Midpoint peg orders can be used by traders to discover hidden orders and those in what are referred to as dark pools.
The term Not-Held refers to broker instructions that permit discretion in order to obtain the best possible price on a security. Not-Held orders are typically associated with market or limit orders.
The term order book is used to describe a listing of buyers and sellers interested in exchanging certain securities. Oftentimes an electronic matching engine is used to determine which transactions can be successfully executed.