Anonymous Trading Definition

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Anonymous Trading Definition

What Is Anonymous Trading?

When high-profile investors conduct transactions that are visible in an order book but do not expose their identities, this is known as anonymous trading. While most traders deal anonymously, bigger merchants choose to keep their involvement in a market hidden for a variety of reasons.

Many stock exchanges, including the London Stock Exchange (LSE), Toronto Stock Exchange (TSX), New York Stock Exchange (NYSE), and NASDAQ, as well as dark pools, allow some users to trade anonymously.

Key Takeaways

  • Anonymous trading may be useful for major traders who do not want to reveal what they are buying or selling to other dealers.
  • No regulated order is completely anonymous since transactions must still be completed and cleared, and regulators must still have access to trade information if they so want.
  • Retail traders don’t need to worry about trading anonymously since their orders seldom have a big pricing influence, and other traders aren’t especially bothered with smaller one-time transactions.

Understanding Anonymous Trading

Anonymous trading is largely used to avoid alerting the market to an impending move, which might result in front-running or jockeying for the best position in an order book.

For example, a major institutional buyer interested in purchasing millions of shares may not want to make their intentions known until the transaction is completed. Smaller investors may bid up the price in the hopes of selling it to the institutional buyer for a fast arbitrage profit, or pennying may be employed to unjustly acquire execution priority.

Pennying occurs when other traders raise their offer by a penny, cutting in front of a trader who submitted a penny lower first bid. Traders will often do this if they discover an interested party eager to acquire significant quantities of stock. They cut them off, knowing that the bigger group will almost certainly continue to purchase even at increased costs.

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Anonymous trading may take place in three key venues:

  1. Due to competition from anonymous trading electronic communication networks (ECNs), several big stock exchanges began to provide anonymous trading while accessing the central order book. Other stock exchanges have hybrid trading systems that allow for the execution of automated anonymous orders as well as non-anonymous auction orders.
  2. Dark Pools: Through dark pools, several ECNs provide anonymous trading. Dark pools are private asset exchanges that offer extra liquidity and anonymity for trading big blocks of assets away from public scrutiny.
  3. Inter-Dealer Brokers (IDBs): IDBs arrange and execute deals in listed and OTC financial markets on behalf of institutional customers. IDBs often deal with big blocks of securities when trading activity is low or when customers want anonymity on their transactions. When an IDB makes a deal on behalf of a client, only the broker’s identity is exposed, not the client’s.

Dark Pools

Dark pools are secret marketplaces that trade securities that are not available to the general public. The name of these exchanges, often known as “black pools of liquidity,” refers to their utter lack of transparency. Dark pools were created largely to assist block trading by institutional investors who did not want to disrupt markets with huge orders and get poor pricing for their transactions.

Dark pools are commonly viewed in a negative light, although they serve a function. However, their lack of transparency exposes them to possible conflicts of interest on the part of their owners and predatory trading activities on the part of certain high-frequency traders. While dark pools provide obvious benefits to major players, the lack of transparency that is their main selling point also has a number of drawbacks. These include pricing disparities from public markets and the possibility of misuse.

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Special Considerations

The majority of anonymous trading is done by professionals and options market makers. Anonymous transactions have a bigger price effect, which is why the traders placing these enormous orders want to remain anonymous. However, putting anonymous orders may give other traders the impression that the anonymous trader does not wish to be identified, which may lead to front-running or pennying.

It is important to understand that no trade on authorized exchanges is completely anonymous. Finally, settlement must occur, and authorities must have access to trade information in the event of a questionable transaction. In this context, anonymity implies protecting one’s identity from other traders but not from regulators and other parties that must arrange the actual deal and its settlement.

Small retail traders do not need to worry about anonymous trading because their orders have little price impact, other traders are not particularly concerned with the actions of other small traders, and most retail traders trade through large brokers with thousands of traders, so their identity is obscured to other traders anyway.

Example of Anonymous Trading on a Stock Exchange

When a transaction is placed via an ECN or exchange, the trader’s exact identity is not made public. The identity of the individual making the transaction is unknown to other traders, but the brokerage or business used to conduct the transaction is visible.

A transaction list for a Toronto Stock Exchange (TSX) listed stock, for example, will include the time of the transaction, the price, the quantity, the exchange, and the buyer and seller broker/firm codes. This might reveal information on who is buying or selling, particularly if the business has few customers or trades its own cash.

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By placing an anonymous order on the TSX, a business may keep its identity disguised. This is represented by the code 001, which stands for anonymous.

The TSX provides statistics on anonymous trading every month, indicating how many anonymous transactions each business executed in the preceding month. This adds some transparency to anonymous trading while still keeping other traders from knowing who is putting deals in real time.

Anonymous trading is not significant for retail traders dealing via a major broker since the brokerage has so many customers that the broker is continuously making transactions in most stocks. Only exceptionally high volume passing via a certain broker may alert other players who are aware that certain customers deal with that broker.

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