Wall Street is back to dealing in the dark.
In the wake of the coronavirus-triggered market meltdown, off-exchange trading hit an all-time high share of the U.S. stock market, 44.93%, on April 27, according to Rosenblatt Securities. It was the third consecutive trading day where a new record was set.
Off-exchange trading, which includes everything from private stock markets called dark pools to trading giants using their own money to complete investor orders, steadily climbed to its record share throughout April, the S&P 500's best month since 1987. That came even as volatility persisted at levels well above normal. Usually, stock trading tends to concentrate on the heavily regulated "lit" exchanges run by the Intercontinental Exchange Inc.-owned New York Stock Exchange, Nasdaq Inc., Cboe Global Markets Inc. and IEX Group Inc. during more volatile markets as investors hunt for immediate liquidity, as was the case for much of February and March.
The biggest difference this time? Mom and pop investors.
"A lot of folks are now sitting at home subject to stay-at-home orders, so they might be more likely to trade than they would be if they were in the office all day," Rosenblatt Securities Managing Director and Partner Justin Schack said in an interview. "Usually when something gets cheaper, you get more of it."
Charles Schwab Corp., TD Ameritrade Holding Corp. and E*TRADE Financial Corp. have seen a flood of buy and sell orders from their clients as markets have whipsawed in the free-trading era. Average daily trades nearly doubled at each of the online brokerages during the first quarter compared with the prior-year period. The activity seems to have continued throughout April. In a recent statement, TD Ameritrade Interim President and CEO Steve Boyle said daily average revenue trades totaled 3 million between April 1 and April 20, versus a little more than 2 million in the prior three months.
How large swaths of retail investor orders end up off-exchange comes in part by way of wholesale market makers, such as Citadel Securities LLC and Virtu Financial Inc., which execute the orders on the broker's behalf with the promise of providing better trading prices. While market makers may end up executing the trades on an exchange or in a dark pool, they often wind up internalizing a large portion of the orders by using their own capital to complete them.
While trading tends to concentrate on lit exchanges during volatility because they display more liquidity, off-exchange trading does benefit the market in other ways, said Adam Inzirillo, head of U.S. equities at Cboe.
"Wholesalers can step in and provide a function that you couldn't otherwise get in a public market," he said in an interview. "They serve a valuable function to the retail community."
Internalization is not the only form of off-exchange trading that has seen a recent jump in activity.
Dark pools, known formally as alternative trading systems, or ATS, are effectively private stock markets run by some of the world's biggest banks and brokerages including UBS Group AG, Credit Suisse Group AG and JPMorgan Chase & Co.
Although April data is not yet available, equity trading volumes on dark pools ticked up in March and represented roughly 14.16% of the total market, according to Rosenblatt Securities.
The UBS ATS, which is the largest U.S. equities dark pool, saw the average number of shares it matched nearly double to 380,742,311 in March from 194,850,675 in February. More than 1 billion shares traded on the UBS platform on March 18 alone, according to Vlad Khandros, global head of market structure and liquidity strategy at UBS.
"When we look at our market share, we've seen it pick up," Khandros said in an interview. "As retail trades more heavily and the retail market makers interact with that flow, there is a chance they are sending more of it to the UBS ATS."
Large institutional investors have been piling into dark pools to amass or dump blocks of thousands of shares at a time as well. Because they do not have to publicly display live data about trading on their venues, dark pools offer a haven for block trading as institutional investors do not have to worry about spooking the market and driving a stock price in the opposite direction.
UBS has seen a "material uptick" of block trading on its ATS, said Khandros, who is also global co-head of principal investments and strategic ventures at UBS. In March, the Swiss bank reported that 3.27% of its dark pool's average daily volume came from block trades with at least 10,000 shares. By comparison, block volumes regularly accounted for 2.2% to 2.4% of trading on the ATS in 2019, Khandros said.
Luminex Trading & Analytics LLC, a Boston-based dark pool operator created by nine asset managers including BlackRock Inc. and Fidelity Investments, runs one of the largest dark pools for block trades.
According to data from the Financial Industry Regulatory Authority, the Luminex ATS handled 3,376 trades of at least 10,000 shares in the month of March, with the average size of each totaling 60,343 shares. A month earlier, the ATS saw 1,922 block trades with an average size of 49,843 shares. Typically, block volume falls as volatility rises, according to Luminex CEO Jonathan Clark. But portfolio managers' mindsets shifted in the latest sell-off from one of patience to one of urgency.
"They had to move stock, they couldn't wait," Clark said in an interview. "In this environment, a lot of traders are of the mindset that if something shows up, they are going to 'hit the button.'"