The Headlines suggesting mystery and risk are posted for all the world to see at www.finextra.com:
“ITG to launch “dark liquidity” crossing platform in Europe.”
“Goldman launches off-exchange trading platform in Europe.”
“JP Morgan launches “dark book” algorithms.”
“JP Morgan’s Neovest provides access to 15 “dark liquidity” pools.”
…and at www.financetech.com:
“Lehman Brothers and Fidelity Brokerage link their “dark pools.”
The significance of “dark pool” transactions cannot be underestimated - - a recent estimate is that 10% of all equity transactions occur in “dark pools,” and that this number is growing.
For those not inclined to visit finextra.com’s or financetech.com’s websites to read the very revealing articles, the following excerpts will provide a sampling of the import of ‘dark liquidity’:
Regarding JP Morgan’s subsidiary: “Neovest has established connectivity to 15 ‘dark pools’ of liquidity - - trading networks that do not publish quotes in the open market…”
“Neovest currently provides access to over 100 broker destinations and a range of dark pool algorithms….”
Regarding Goldman Sachs’ new platform “…the new platform will provide customers with access to deals that are not offered publicly on any exchange…(to) provide clients with access to dark liquidity pools.”
Regarding the ITG ‘dark liquidity crossing platform,’ “the system’s total anonymity ensures that there is no leakage of information into the market and therefore price impact is minimized, says ITG.” (emphasis added)
Regarding dark liquidity pools managed via ‘dark book’ algorithms: “Earlier this year electronic broker Instinet launched a ‘stealth liquidity aggregation algorithm’ called “Nighthawk” and “JP Morgan Chase has launched Aqua and Arid, two institutional trading algorithms that have been designed to stealthy trade stocks on dark books - - trading networks that do not publish quotes in the open market…”
In considering ‘dark liquidity,’ ‘dark pools,’ ‘dark algorithms,’ ‘dark books’ and the like, Deepcaster’s initial reaction was “What about the ‘Theology’ of the free and open and fair marketplace” with which we are inculcated?” And what about the manifold opportunities the ‘dark pools’ provide for The Cartel to implement Market Interventions without scrutiny? [Those not familiar with the Market Interventions of The Cartel of Central Bankers or Government Data Manipulation are encouraged to read Deepcaster’s October, 2006 Letter: “Juiced Numbers IV - - How The Government Gets the Statistics It “Wants,” Markets Get Manipulated, Citizens Get Deluded, and Worse” at www.deepcaster.com. Deepcaster also recommends the Gold AntiTrust Committee’s website www.gata.org for an excellent description of The Cartel’s suppression of Gold and Silver prices.]
- It is pretty clear that the ‘dark pool algorithms’, which are designed to trade large orders in liquid markets, are automated trading operations otherwise known as “program trading.” But haven’t automated trading platforms played a big part in major company and market meltdowns?
- Isn’t an essential part of any investors’ sensible risk evaluation a function of evaluating counterparty risk? That is, a counterparty is the party who takes the other side of any particular investment transaction in which any of us is involved? But the capacity to make good on any such transaction is a function of counterparty strength or weakness. Suppose the counterparty fails? And suppose the counterparty on any particular investor transaction is at great risk because of its ‘dark book’ transaction with other ‘dark’ parties. Who would know, and how could the risk be evaluated?
Indeed, we certainly have enough recent examples of Counterparty Failure to cause concern. Consider that the Amaranth Hedge Fund in recent months and Long-Term Capital Management in recent years are only two examples of this.
- Moreover, consider the foregoing in conjunction with a couple of other observations by noted financial observers:
“The inflationary recession continues to deepen with economic reporting generally surprising markets on the downside of expectations and inflation surprising markets on the upside.” April 3, 2007 Flash Alert, John Williams, Shadow Government Statistics. That is, Williams’ is describing our current state of stagflation.
Couple this observation with one attributed to Mark Precter (the Elliott Wave theorist) which we paraphrase as follows: “Currency inflations can go on forever, but credit inflations have a finite end point.” Indeed are we not seeing the beginning of the end of the massive (Fed Caused) Housing Credit Market inflation that we have seen in recent years manifested, for example, in the New Century Financial bankruptcy at the beginning of April, 2007?
Does not the “darkness” of “dark pools” impair our capacity to cope with the foregoing challenges?
- And what about “Fundamental Fairness” and “Level Playing Fields” in The Markets? Equal timely access to price information is essential to fairness to the investing public but “dark pools” and “dark transactions” in principle limit such information to the privileged few.
- And what about “conflicts of interest?!” One blogger wrote: “But if a bank sets up an (dark pool) exchange, some of the biggest traders on the exchange will also be the bank’s biggest customers in other areas. This is a massive conflict of interest situation. Remember what happened in the 1990s when investment banks noticed that their equity research divisions could be used as a marketing tool? Imagine using execution speeds and pricing for the same purpose.”
- And what about lack of oversight?
- And what about the potential for fraud?
- And, above all, for the investor, do these “dark pools” not put at risk all their hard earned wealth and profits, as a result of some “dark pool” event which has not been foreseen or planned for?
It certainly seems that the lack of transparency, in dark pools and dark books, lack of the ability to evaluate counterparty strength, conflicts of interest, and the continuing stagflation and impending credit bubble bursts certainly do not bode well for the future or for portfolios, unless one can develop an approach which addresses these issues.
So how does one protect from and profit in spite of these risks? This poses a considerable challenge. A significant focus of Deepcaster’s Letters and Alerts is aimed at answering these questions. But the following observations may provide some partial answers:
1) Keep a significant portion of your wealth in real and tangible assets (subject to Timing Considerations) which the public needs and regularly uses. Deepcaster has identified certain of these assets and addresses the Timing Considerations in his recent Letters and Alerts.
Even though The Cartel may manipulate the prices of these Tangible Assets down from time to time, in the long run one will be rewarded for owning them, if they are in great demand.
2) Attempt to make, although it may be very difficult, an evaluation of counterparty strength. Regarding options, for example, are they clearinghouse guaranteed? And how strong is the clearinghouse?
3) “Go Local.” Deepcaster is working on a piece which will elaborate on this injunction.
4) Develop an investing and trading regime for certain key tangible assets markets to minimize or avoid the impact of Cartel Initiated Takedowns. In this connection, Deepcaster has developed an approach for investing and trading in the Precious Metals markets described in its April, 2007 Letter at www.deepcaster.com.
5) Push for Transparency.
6) Ask The Regulators for oversight.
7) Stay informed. Given the rapidity, magnitude, and increasing significance of “dark liquidity” transactions, failure to stay informed can be lethal. But, since the transactions are “dark” staying informed is difficult, to say the least. And that is a primary challenge.
Let there be light!
Deepcaster
DEEPCASTER LLC
www.deepcaster.com
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