(This is part of a series about dark pools of liquidity, increasingly popular anonymous trading venues that are changing the way stocks are bought and sold around the globe.)
The financial exchanges sector has been transformed by the rapid growth of dark pools -- private, anonymous, electronic trading venues that compete with exchanges for their largest, most profitable orders.
The following lexicon explains some commonly used terms in the sector:
Algo-trading: Automated buying and selling of securities measured in thousandths of a second, based on computer-generated instructions to execute a trade when certain conditions are met.
Alternative trading system (ATS): Often backed by broker-dealers, they include electronic communication networks (ECNs) such as BATS Trading and block crossing networks such as Block Interest Discovery Service (BIDS).
Block crossing network: An ATS that handles large chunks of stock for institutions, which may be matched in a "dark pool". One of the most established block crossing networks is private equity-backed Liquidnet.
Block Trade: A large order to buy or sell securities, usually 10,000 shares of stock or more. The average order size for equities on public exchanges is 250 shares.
Broker-Dealer: Individuals or firms that buy and sell securities for themselves or others. Broker-dealers generally register with the SEC and join a self-regulatory organization, like NASD. Some of the largest broker-dealers, like Merrill Lynch and Lehman Brothers, have invested in ATSs such as LeveL.
Dark pools: Off-exchange stock trading venues where buyers and sellers anonymously match large orders but keep details about price and volume concealed. Block-crossing networks are one kind of dark pool. Dark pools are popular among investors who want to sell large amounts of shares without attracting notice or having an impact on price.
Electronic communications network (ECN): An ATS that automatically matches buy and sell orders among subscribers. Large ECNs include DirectEdge and BATS Trading, backed by investment banks Lehman Brothers, Morgan Stanley and Credit Suisse.
Execution: The completion of a buy or sell order for a security. Brokers operating on public exchanges are required by law to give investors the best execution price available.
Gaming: Manipulating the price of a stock to increase profits at the expense of the investor on the other side of the order in a dark pool. Common anti-gaming features offered by dark pools include setting minimum order sizes and prequalifying participants that meet a certain profile.
Indications of Interest (IOI): An IOI is an expression of interest in buying or selling a specific security sent electronically by a broker to a specific set of potential counterparties. After that, an interested counterparty negotiates and tries to complete the trade with a broker. Brokers feel this practice undermines the anonymity sought in dark pools by being a potential source of information leakage.
Internalization: A process where broker-dealers use internal inventories to settle trades, sidestepping exchanges and saving on execution fees but potentially raising conflicts if brokers are pressured to execute in-house.
Liquidity: The widespread availability of a given security that makes finding buyers and sellers easier without huge swings in security prices. Dark pools are called that because they offer pools of liquidity which facilitate matching of buyers and sellers while assuring anonymity.
MiFID: The European Union's recently enacted Markets in Financial Instruments Directive is viewed by some analysts as the European equivalent of Reg NMS, likely resulting in greater competition for European exchanges. In response to MiFID, ECN's are expected to proliferate in Europe.
Millisecond: One thousandth of a second, used to measure time it takes to execute a transactions. The standard now on ECN's is trading execution faster than one millisecond, whereas five years ago, speed was measured in seconds.
Ping: The most common way to glean information about an order in a dark pool. Often considered a type of gaming, an investor submits a small order to a dark pool to gauge liquidity. After determining there is liquidity, the pinger will drive the price of the stock up or down on the public exchange by buying or selling a few shares in the market. The pinger will then return to the pool to execute at the manipulated price.
Price Discovery: The ability to know what prices are available for a given security through order display books and other publicly available information.
OTC trading: Over the counter, or the trading of securities among a network of dealers rather than an organized exchange such as the NYSE or NASDAQ. Bonds and foreign currency are traded OTC among dealers.
Regulation NMS (national market system): Regulations designed to update U.S. markets for new, rapid-trading technologies that require automatically executed stock orders to be carried out at the best available price, even if that price is not available on the exchange that receives the order.
Compiled by Phil Wahba in New York