Barclays Not Smart
To sum this up:<p>A "dark pool" is simply a trading exchange where orders aren't published (trades, of course, are). Huge investment banks run dark pools as a service for clients. The premise behind a dark pool is that institutional buy-side investors would use them instead of a lit exchange because they want to trade against other buy-side investors, without market-makers and aggressive, automated sell-side firms to skim off their profits. Barclays LX is a dark pool set up by Lehman.<p>It turns out that the idea that big buy-side investors can trade with each other without middlemen in a dark pool is probably a fiction. The premise probably doesn't hold. There are at least two big reasons for this:<p>1. Giant institutional investors tend to take similar positions. If one giant firm is gobbling up FCOJ, the others probably want to trade in the same direction. So when you restrict your trading partners to similarly structured and sized firms, you tend not to have counterparties to take the opposing sides of trades.<p>2. The timing of decisionmaking at giant firms is slow, and there aren't all that many of them relative to the market as a whole. So even if there are counterparties to match for trades, that match probably doesn't happen within the window of time that the traders actually want to trade (you want to move a block of stock in minutes or hours, but if you can only trade with other giant mutual funds, it might take days to find a match; think about the difference between filling a market order on ETrade versus trying to sell your house).<p>So for Barclays to make LX actually do something, rather than just acting like a frustratingly inert list of big firms, they needed to get sell-side firms to trade there too. Which they did.<p>The subtext of the Bloomberg post is that getting the sell-side into the LX dark pool was probably a necessity, because when you look at the revenue numbers, Barclays was making its real money from the buy-side; the HFT traders paid it a pittance compared to the mutual funds. All things being equal, it was economically irrational for Barclays to court HFT firms. Of course, in reality it was entirely rational, because without the automated traders, no trades would have happened at all.