With today’s fragmented markets, firms are faced with an increasingly wide choice of trading venues on which they can execute their business. The majority of these fall into one of two categories; either lit markets or so-called dark pools of liquidity. However, there is a third way. An increasing number of market operators are now starting to adopt a “twilight pool” approach, where the level of opacity is controlled to match pre-defined conditions.
A twilight pool is a liquidity venue that is essentially dark, but which illuminates certain elements of information regarding market activity for periods at certain times of day or under specific circumstances, generally for the purpose of attracting more liquidity at those times and matching buyers and sellers. Think of it as speed dating for market participants, but only under semi-lit conditions.
In practice, this can be via colour coding on a trading screen for example, with heat maps showing the best bids and offers for short period of time before hiding them again. These heat maps can show levels of activity in the market, without necessarily giving too much information away, such as any indication of size or depth on the bid or offer. All of this information can also be provided – during the “speed dating” periods – through the venue’s trading API, allowing the data to be picked up by smart order routers, for example.
The great thing about twilight pools is that they maintain the advantages of dark pools while still offering some of the benefits of lit venues.
Dark pools of liquidity serve an important purpose in that they enable investment firms to shift large quantities without “showing their hand” and opening themselves up to the possibility of adverse price movements, which is often what happens when they try to execute large transactions on a fully lit venue. This is particularly the case in less liquid products where, even if they use clever execution algorithms, those algos still leave footprints and run the risk of being identified and “sniffed out” by some of the more predatory trading firms.
However, the disadvantage of dark pools is that firms generally have no idea what might be in the pool before they go in. They cannot see existing bids or offers, or event the amount of trading that is occurring. There is no visible indication of liquidity at any particular point in time. Whereas a twilight pool allows all of the anonymity of dark pools to be maintained, while illuminating aspects of the market during key periods, in effect offering the best of both worlds.
At Baymarkets, we have been working with a number of market operators to introduce twilight pool functionality. By controlling the levels of transparency or opacity they are applying to the market at any point in time and being able to focus trading activity at specific times of day, dark pools offering this kind of “speed dating by candlelight” capability are attracting liquidity from previously untapped sources. And in the new world of fragmented markets, the ability to attract and keep liquidity is essential for any trading venue.