Two Shades of Opacity: Hidden Orders versus Dark Trading

Abstract

Regulators are concerned that large volumes of trading outside lit venues (i.e., dark
trading) harms the functioning of financial markets. In contrast, regulators are neutral about
hidden-order trading as these occur on lit venues and are associated with positive effects on
market quality. An unanswered economic question concerns the interrelation between these
two types of opaque trading, i.e., hidden orders and dark trading. Employing two different
empirical methodologies we find that dark and hidden-order trading are substitutes. We
also show that both types of opaque trading increase when markets are volatile and fewer
algorithmic trading occurs. Smart order routing increases dark trading but reduces hidden-
order activity.

Keywords: Dark Trading, Hidden Orders, Dark Pools, OTC Trading, Opacity, Transparency

JEL Classification: G10,G15