“Work some in the dark and keep me quiet. Derivs mod.”

Wall Street has its own language, and these were the unofficial order instructions I got one day. My client was trying to buy stock in a company without anyone knowing about it.

Why keep it quiet?

Well, professional investors have more reasons for what they do than toddlers have moods. For everyday folks like us, we love a company’s story, or we get a hot tip. We open our phone apps and become proud owners of a stock in just a few seconds.

Simple.

But for pros, it’s anything but.

And today, we’ll continue digging around the dark and murky world of how Wall Street really works by tackling a particularly mysterious topic… dark pools.

Animating the Markets

Hi, I’m Jason Bodner, and as most readers know, I’m the editor of Outlier Investor here at Brownstone Research. I put my years of experience on Wall Street to work on regular investors’ behalf… Showing how we can profit using my own “insider information.”

As I’ve been showing in recent weeks, Wall Street operates by a different playbook. And very few people have a clear idea about what goes on behind the scenes. That can put us at a disadvantage.

That’s why I’m now working to shine a light on many of Wall Street’s inner workings… Showing regular folks what to avoid and how they can finally turn the tables on the “Big Money.”

This leads me to why professional investors will often trade in many ways that are difficult for us to understand…

As an illustration, big hedge funds might buy shares when they are bearish on a stock. Sometimes they might test the appetite of competing sellers by buying some stock. Or more often, a client might buy shares as a hedge against a bearish bet.

For example, if I buy a put option on a stock, it generally implies I think it might go down. If I own stock and worry it’ll drop, I can buy a put to protect my stock purchase like an insurance policy.

But if I buy only a put – a straight bearish bet – it’s similar to having a short position in a stock. I believe it will fall. But what if I’m wrong?

In simple terms, I can hedge my long-put position by purchasing a corresponding percentage of stock.

Believe it or not, I have seen clients buy a stock at one brokerage and sell it at another. This is known as “painting the tape” – and it’s technically against the rules.

This is when players attempt to influence the price of a security by buying and selling it among themselves to create the appearance of substantial trading activity. If I buy here and sell over there – and get my buddies to the same – I can animate a market and create interest in a stock where there is none.

But why would I want to do that?

Imagine I have an investment thesis in a stock that is thinly traded. I manage billions of bucks, so when I want to take a position, it’s got to be meaningful. If I can’t go out and just buy some stock – because there might not be enough volume to support the quantity I need to buy – I may try to animate the market.

Of course, I must play by the rules, or I get slapped on the wrists.

So I’ll employ all sorts of games to hide my trading…

Like Trading in a Pitch-Black Room

One of those games might be a trader selling shares at another broker at a loss from a prior long position. And at the same time, the same trader could give me an order to buy shares.

Of course, that could break yet another rule. The wash sale rule disallows selling at a loss and buying a substantially similar security within 30 days. But this rule gets into a gray area when you mix in derivatives like futures, options, and warrants.

In the example above, where the trader sold elsewhere and bought with me, it would be fine as a hedge on a long-put position, as long as it was marked as such.

That brings me back to the client order I shared at the start of today’s essay…

This order was given to me with a “derivs” mod, which is where the client wanted me to buy shares quietly, but mark it as a stock trade linked to a derivative. And he specifically referenced dark pools.

“Dark pool” sounds mysterious and almost sinister. But it’s simply a “dark” pool of liquidity. But placing orders in dark pools allows absolute secrecy.

Here’s how it works…

Imagine walking into a pitch-black room with a key. You can’t see anyone or anything. Instead, you just hold out your key in front of you and walk blindly around, hoping someone else has a matching lock. If you’re lucky enough to link up, your problem is solved.

If not, you wander around aimlessly until the end of the day and emerge still holding your key. 

That’s it.

Dark pools are matching engines that keep anonymity between buyer and seller. Neither party knows who the other is when a trade gets consummated.

Additionally, orders are not advertised.

Normally, you post your bid price for a certain quantity of stock for all to see. A lot of buyers posting bids means clear buying pressure. Sellers respond by raising their offers. It can be frustrating when you’re trying to get the lowest price possible.

On this occasion, however, I managed to buy 200,000 shares of a $50 stock – or $10 million in the dark – without anyone knowing about it.

That is… until the end of the day.

And here’s where it gets interesting for you to tilt the tables in your favor…

By law, every share of exchange-listed stock that changes hands must be reported to the aggregated tape by the end of the day.

That includes dark pools.

Every share gets reported by law. So why does this matter to us?

If you know what little games are being played behind the curtain, you’ll know how to recognize when it works against you. Or better yet, if you get an early heads up when Big Money is moving into a superior stock, you can use it to your advantage.

And that’s where my analysis process comes in…

Tracking the Big Money

My computers look at more than 6,000 stocks every day, scanning for when unusually big trading happens. But instead of being glued to a screen all day, I go to sleep.

My machine does its work at 2 a.m. It waits until then because, by midnight, all reported volumes of stocks must be complete. Any share that is traded anywhere is reflected in the daily volume figure.

That includes dark pools.

That’s why no matter what anyone is trying to do to keep themselves quiet, I can see their movement within hours of them trading. It’s like having X-ray vision for the stock market.

And when the Wall Street honchos try to play their games to tilt the odds in their favor? I see it.

Each and every share – every day.

And that is how I know where the Big Money is moving in and out of stocks. Then, when Big Money starts buying the best-quality stocks, I sit up and take notice.

That is what Outlier Investor is all about. We profit by taking advantage of these “hidden” moves on Wall Street. It’s how we’ve made gains like 149%, 125%, 373%, and 707%.

So if any readers would like more info on how this works, I’d encourage you to click here for all the details.

And then make sure you keep tuning in to The Bleeding Edge every Saturday, where I’ll continue to share my insider’s insights on Wall Street and the markets.

Talk soon,

Jason Bodner
Editor, Outlier Investor

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