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Warrior Trading's Ross Cameron: Don’t Fear the Dark Pool

Dark pools, black-box trading, algos, high-frequency trading, ATSs … To the day trader, it’s enough to make your head spin. But Warrior Trading’s Ross Cameron says day traders need not fear the dark pool.

“Dark pools have been named so because of their lack of transparency,” explains Cameron’s Warrior Trading website. “They were established by institutional investors with the intention of not impacting the market thanks to large orders and adverse prices, whether it be for stocks or other financial instruments.”

It’s been decades since accessing the stock and bond markets meant running across a physical trading floor, a paper bid in hand, shouting “buy” or “sell” at a man on a platform waving a handful of trading slips. Back in the day, the only way nonprofessionals could trade the markets was by calling their broker on the telephone and waiting precious minutes, hours, or even days to find out if they’d gotten the price they wanted. With the internet, high-speed connections and public trading platforms brought direct market access for everyone and the ability to trade on your own. The day trader was born.

But these technological advancements were also the catalyst for a whole new species of trader that many see as in direct competition with day traders.

Warrior Trading’s Ross Cameron Says Be Aware, but Not Wary, of Dark Pools

Day traders operate in a deeply segregated market in the sense that there are pools of liquidity that do not mingle.

Institutional traders often use dark pools to access liquidity that retail day traders cannot access — and that’s a consideration for every trader, says Warrior Trading’s Ross Cameron.

“If you’re a trader that’s outside that pool, you can’t get access to that liquidity,” Cameron states. “The downside to that is clear. Shares may be for sale, and you may want to buy them, but you cannot access them. The result is that you will pay a higher price to buy different shares for sale within your designated pool of liquidity.”

Let’s say a trader wants to buy 50,000 shares of a stock. That would be a big position. And let’s say that within a certain dark pool, there’s someone who’s trying to sell 50,000 shares. Unless the seller is willing to route the order out into the lit market, therefore risking showing other market participants that there is a large seller coming to the table, the two will never meet. If the buyer tries to buy those 50,000 shares on the lit market, the buyer is trading in a much smaller pool of traders and will get a lot more slippage on their order. Slippage means they’ll pay a higher price.

“They won’t get the best execution,” says Cameron, adding that there’s some debate among regulators about the segregation in the markets that payment for order flow has created.

“By allowing dark pools to operate, the regulators have allowed the market to become very segregated. Traders might get a better price and better execution on their orders if all orders went into an auction where they were competing openly together.”

Warrior Trading’s Cameron notes that retail brokers also execute a lot of the retail transactions internally within the dark pools operated through payment for order flow wholesalers.

The advent of dark pools and ATSs, Cameron explains, has led to the start of choice for day traders.

With multiple pools of liquidity operated by different market participants who offer different types of engagement, day traders have a wealth of options in how they access the markets.

“Traders should have a choice of payment for order flow and trading in the lit markets,” Cameron says, adding that some pools can be accessed for free while others charge a fee, depending on their business model. “There’s an argument that the free commission brokers using wholesale market makers are actually able to get price improvement because of their ability to do something exchanges can’t do — which is to split the penny and offer prices in fractions.

The Quick FYI on Electronic Trading

Before you jump into the deep end of a dark pool, it’s best to know how to navigate electronic trading.

Faster internet connections meant institutions and hedge funds could buy in volume — fast. Advances in machine learning and artificial intelligence meant they could create complex computer programs — algorithms, or algos — to formulate and execute trading strategies without the need for a human to make a decision. Soon, hedge funds with large war chests realized they didn’t need to pick the best-performing stocks to make a ton of money. Instead, their algorithms could identify small moves in the market and buy in bulk to create the massive gains they were after. Enter the era of high-frequency trading.

But as HFT became an ever more popular strategy, they began sucking large volumes from the market, creating deserts of illiquidity. As a defensive reaction, the dark pool was invented — private forums where liquidity is taken off the main market so members can find the stocks and liquidity they desire.

Yet the liquidity in dark pools isn’t always readily accessible to most day traders. So, they’re left at a clear disadvantage in the fight for price movement and liquidity against traders operating in dark pools.

At least, that’s the conventional wisdom. Yet Warrior Trading’s Ross Cameron — one of the most successful day traders of the current era — doesn’t quite see it this way.

Ross Cameron’s Method for Tapping Dark Pools

In his own trading, says Cameron, rather than angst over the liquidity challenge of dark pools, he factors it into his execution strategy.

“One of the things that I have found with day-trading is that I can try to execute my orders against some dark pools. The broker that I use is a direct access broker. It’s not a retail broker, so I can choose exactly which destination my order goes. It could go to NASDAQ, to the all-electronic exchange Arca, or to [global stock exchange operator] BATS. I can also try to fill orders on dark pools.”

For instance, Cameron has found that generally, when he’s trading a small-cap stock that has a relatively high relative volume one day but light volume in general, there’s usually not a match for his order in the dark pools.

“So, if we think back to the origin of the dark pools, it was in a large part about being able to execute orders without tipping your hat to other market participants that you were putting a big order out in the book. You were able to put an order out there that others weren’t able to see, but then a match could be made anonymously,” Cameron says, explaining that dark pools don’t publish a quote book. “I think in the case of a lot of small-cap stocks, there’s just not enough interest among big institutional traders to create added liquidity in so-called dark pools. Most of the time when I send my order to one of the listed dark pools available for retail traders, the order just sits there without finding a match.”

Ross Cameron has a similar mindset to algos and HFTs.

“Day traders need to be aware that these exist, but they don’t need to fear them,” Cameron says. “They’re just another participant in the market. A source of competition for price, yes. But also a source of liquidity.”

The upshot? Dark pools might seem scary, but the more you get to know them, the more you can use them to your advantage.

This article does not necessarily reflect the opinions of the editors or management of EconoTimes

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