Behind the prosperity of retail investors, Wall Street enters the "dark pool" era

With the vigorous development of retail trading, over-the-counter (OTC) trading is gradually becoming dominant, and the U.S. market is entering the "dark pool" era.

On Friday, according to Bloomberg data, the proportion of OTC trading in U.S. stock trading has for the first time consistently exceeded 50%. Dark pool trading, which occurs outside of public exchanges, now accounts for 51.8% of the total trading volume in the U.S. stock market, reaching a historical high in January and setting records for five consecutive months.

Anna Ziotis Kurzrok, head of market structure at Jefferies, pointed out:

This shift "seems to be developing into a long-term trend and is likely to become permanent."

For many years, public exchanges like the New York Stock Exchange and Nasdaq have dominated market activity, but the rise of dark pool trading is changing this landscape. The importance of exchanges lies in the quotes they display, which serve as the benchmark for most market participants to price stocks. However, as more and more trades shift to dark pools, the influence of exchanges is diminishing.

Larry Tabb, head of Bloomberg Intelligence's market structure, stated:

If this trend continues, it could ultimately affect the way the market operates. Theoretically, the more OTC trading there is, the fewer orders there are competing on exchanges to determine the best price. This means that pricing both on and off the exchange could deteriorate.

The U.S. Securities and Exchange Commission (SEC) has taken steps in recent years to try to push more trading activity back to exchanges through market structure reforms. However, of the four proposals put forward by the SEC, only two rules were ultimately passed, which adjusted the way stock pricing and trade execution are conducted.

Analysis shows that the surge in OTC trading activity is related to the increase in trading volume of stocks valued below $1, which are typically traded by retail investors. These trades are often handled internally by market-making giants like Citadel Securities and Virtu Financial. Excluding the data for stocks below $1, OTC trading remains below 40% of total trading volume. This indicates that the growth of OTC trading does not necessarily mean that trading for individual stocks or all stocks will deteriorate.

Additionally, the rise of alternative trading systems (ATS) provides institutional investors with an alternative way to process trades anonymously without displaying the desired prices on public exchanges. These systems use different mechanisms to match buyers and sellers, helping institutional investors limit information leakage to the market and avoid adverse impacts on prices.

According to Bloomberg Intelligence's analysis, in November 2023, the daily trading volume of stocks through ATS reached 1.7 billion shares, the highest level since March 2020, an increase of 36% compared to a year ago