Two Shades of Opacity: Hidden Orders versus Dark Trading

Abstract

This paper investigates two distinct ways in which traders can hide their trading intentions: (1) hidden orders on lit trading venues and (2) completely dark trading venues. Using a detailed high-frequency dataset, we find that dark trading and hidden order trading are substitutes. However, dark trading appears to be a better substitute for hidden order trading than the other way around. Furthermore, a number of market conditions differently affect hidden orders and dark trading. In particular, hidden order trading is preferred over dark trading on high volume days, when visible depth is small, the quoted spread is narrow and fewer traders employ smart order routers. Algorithmic trading is negatively related to both types of opaque trading. These findings have implications for regulation aimed at curbing dark trading activity, since hidden orders do not offer an adequate opaque alternative.