This document discusses how quant trading and dark pools have come to dominate the markets in Europe and beyond. It outlines how regulatory changes like MiFID led to growth in multi-lateral trading facilities and off-exchange trading between major banks and institutions. Now, over-the-counter markets with little transparency have much larger trading volumes than public exchanges. Traditional investors and day traders have little chance of success against high-frequency quant strategies that access non-public order flows and data. The landscape has changed dramatically and any trader ignoring these new realities does so at their own peril.

1. Quant Trading:
The Ever Changing Market
Christopher M. Quigley
B.Sc., M.M.I.I., M.A.
Terms:
Q Trading: Quant Trading. The Use Of Mathematical Algorithms To Form And
Identify Successful Investment Strategies.
HFT: High Frequency Trading: The Use Of Computers To Provide
Trading Execution At Many Times Per Second.
OTC: The Over The Counter Market. An Unregulated Decentralized Market
That Mainly Operates Between Big International Banks And Other
Financial Institutions.
VaR: Value Adjusted Risk. Risk Of An Instrument Adjusted For Reward
Probability.
MTF’s: Multi-Lateral Trading Facilities Set Up Between Banks And Financial
Trading Houses. Theses Platforms Use Similar Software That Allows
Interoperability.
MiFid: Markets In Financial Instruments Directive (European Union).
CTA: Consolidated Tape Association. This Association Oversees The
Dissemination Of Real-Time Trade And Quote Information In The New
York Stock Exchange And The American Stock Exchange.
ETF: Exchange Traded Fund.
Flash Trading: The Allowance Of Specific Traders To View Orders From Other Traders
In Fractions Of A Second Before The General Market.
Dark Liquidity: Funds Available For Trading Large Blocks Of Instruments Between
Institutions Unregulated And Unreported To The Public. The Blocks Are
Normally Broken Up To Mitigate Unwanted Intelligence As To Source.,
Volume And Price.
Alpha: Investment Performance In Percentage Above Or Below What Would
Have Been Predicted By Its Risk.
Beta: Measure Of Stock Volatility.

2. The markets in mainland Europe are going through something of a revolution particularly since
the MiFID directive in 2007 from the European Commission. The purpose of this initiative was
to promote competition in the financial markets throughout the Euro zone. As a result all
European exchange venues are promoting themselves as the battle for market share heats up. As
these exchanges reinvent themselves the installation of new technology and new relationships
has led to many unanticipated developments. One such outcome is the diminishment of the
“classic” exchange in preference for MTF’s and the OTC market. It addition, increasingly
traditional forms of trading are being replaced by the Flash, Quant and Dark Pool variety. Any
trader who does not understand the implications of these developments is (not to put the issue too
finely) “living in the dark ages.”
The growth in size and complexity of OTC trades means that this market now dwarfs the main
public markets and in effect the regulated stock exchanges are now nothing but a “bench mark”
for the main action. As Nathan Tiefenbrun, chief executive of multi-lateral trading facility,
Turquoise Europe recently said in “Global Markets”:
“The evidence is that when the primary market stops trading everybody stops trading. They are
the source of official calculations and when you arbitrage a share across different venues, you
need to have that link back to what is happening on the main exchange.”
This situation amounts to a revolution in financial affairs. The major banks and financial houses
are no longer “investing “ to buy and hold but are now only interested in “trading” on their
own account. This institutional trading is in the main quant programmed trading looking to find
VaR, Beta and Alpha through algorithmic analysis. The target trades are then executed through
HFT to get an edge. It is important to note that the funds from these institutions that would have
entered the New York stock exchange and bid up prices and values are now on the side lines
betting on short term price action in dark pools. For those who understand the importance of
technical information it must dawn on them that you cannot have true analysis of volume and
price activity that is unpublished and unreported to the CTA.
As I wrote a few months ago:
“Dark Pools, what are they?” Dark pools of liquidity” are crossing networks that provide
liquidity that is not displayed on order books. This situation is highly advantageous for
institutions that wish to trade very large numbers of shares without showing their hand. Dark
liquidity pools thus offer institutions many of the efficiencies associated with trading on the
exchanges’ public limit order books but without showing their actions to other parties. This is
achieved because neither the price nor the identity of the trading entity needs to be displayed.
Many of the OTC “exchanges “used by the dark pools use high frequency trading programmes to
minimize order size and maximize order execution. Now you may think that this manner of
doing business on the “stock market” is carried out by minor unknown entities but this is not the
case. Below I list the Independent dark pools, the broker-dealer dark pools and exchange-owned
dark pools that we currently know about.
Independent dark pools: Instinet, Smartpool, Posit, Liquidnet, Nyfix, Pulse Trading,
RiverCross and Pipeline Trading.

3. Broker-dealer dark pools: BNP Paribas, Bank of New York Mellon, Citi, Credit Suisse,
Fidelity, Goldman Sachs, Knight Capital, Deutsch Bank, Merrill Lynch, Morgan Stanley, USB,
Ballista ATS, BlocSec and Bloomberg.
Exchange-owned dark pools: International Securities Exchange, NYSE Euronext, BATS
Trading and Direct Edge.
When you understand that all the big players in banking and finance are using the OTC system
and have a turnover 12 times that of the “public” markets you get to wonder why there is stiff
regulation on the public New York Stock Exchange and the American Exchange, yet no such
mandate exists in the OTC market. Surely the SEC is failing in its regulatory duty here.”
At the moment the platforms, systems and strategies being used by OTC traders are experiencing
explosive growth. This growth is sucking liquidity and stability from the main markets. The
small time investor and trader who tries to “time” the market through traditional “day trading”
strategies does not stand a chance against computers that flash trade many times per second
based on “unseen” technical and dark bid/ask price data. In fact any trader who does not take the
new market reality (indicated in particular by the flash crash of May 6th.) into consideration is
going to lose and lose big. The fact that he/she is losing to the major institutions is indicated by
the fact that HFT operators made 21 Billion dollars last year. This figure is set to grow but to the
detriment of the traditional market players. Thus, to state it clearly, I finally quote my favorite
Irish poet:
“All changed, changed utterly. A terrible beauty has been born.”
Easter 1916
William Butler Yeats