Dark Pools, Efficient Markets, and the Human Factor
A Boston Globe story today, Shedding Light on ‘Dark Pools’, includes this from the head of equities at Fidelity’s brokerage arm:
“I don’t mind if the best price is on an exchange or in my own dark pool,” [Michael] Cashel said.
But he also said the 1,200 people on the floor of the New York Stock Exchange still play a useful role, especially at the beginning and end of the day. “It’s good to have someone standing there in the crowd,” he said.
That raises a question: Why do global markets still operate on a parochial schedule? When you can buy and sell virtually anything on the Internet any time — including securities on overseas markets — how does the artificial temporal constraint — Monday through Friday 9:30 a.m. to 4 p.m. ET — on a narrow band of financial products survive?
An initial concern might be: “Think of all those poor people who make their livings buying and selling securities? How could you possibly force them to be on duty 24/7/365?” Another might be: “What about all those pre-open and post-close announcements? Wouldn’t giving some people the ability to trade on those in real time make be unfair to less sophisticated traders?”
A few thoughts:
When exchanges were created before the invention of telecommunications, fixed hours made sense. No one would want to spend their entire life standing under the famous tree in lower Manhattan — or live in the coffee house to which the business was later moved. But that was a different era.
We’ve long observed high volatility at the start and end of trading days. No doubt some market participants have found ways to profit from this phenomena, tautologically at the expense of other participants. Wouldn’t making the stock market work like other modern markets, where in the absence of non-competitive actors like OPEC and similar Smithian groups formed to restrain trade, buyers and sellers maintain equilibrium prices by constantly pursuing their aggregated independent interests, help restore price stability?
One key to efficient markets is buyers and sellers having good information about what they’re buying and selling. Call it “substantive transparency.” Contrast substantive transparency with price transparency, the lack of which is what concerns critics of dark pools. The question then becomes what business and government policies can maximize substantive and price transparency for the purpose of creating wealth?
Substantive transparency, when achieved, works well for the securities of large public companies — so well, in fact, that people resort to less than transparent markets (dark pools) to protect from market attention their decisions to act on that transparency. To achieve 100% price transparency would require a global solution that effectively prevented anyone anywhere on the planet from entering into a private contract with another willing buyer or seller. Good luck.
On the other hand, eliminating opportunities to “game the clock,” at the start or end of the antiquated concept of the “trading day,” seems to be entirely within the control of those who control the clock. Doing so might be an important step to align traditional markets with modern technology.
As for those pre-open and post-close announcements, does that timing really prevent gaming? When trading is driven off of exchanges because exchanges are closed, and when full-timers are in the best position to act at the open and close of exchanges, how effective can it be to time disclosure to happen when exchanges are closed? Might more frequent disclosure of less material information more effectively mitigate price swings, therefore reducing volatility and increasing the confidence of long term investors made nervous by volatility?
