Dark pools and black boxes are out to get us all

Jeremy Thomas: Consider this: you are the holder of a massive block of shares in a company which, for your own good reason, you wish to sell.

If you try to flog such a large chunk on the open market, you risk driving down the value of the holding and raising all sorts of uncomfortable questions about the company.

On the other side of the world sits another asset manager who, after due research, wants to buy all those shares. The buyer also doesn't want do so on a stock exchange, because such a massive trade may well end up costing it a lot more than it intended. Speculators, getting wind of the impending trade, might drive up the price.

Global banks, however, bypass these concerns. Sellers will arrange quietly for buyers to take the shares off their hands at an agreed price. The "dark pool" of assets will find a new owner and nobody at the time, necessarily, will be the wiser.

Dark pools are something stock exchange operators just have to live with. On Monday, for instance, the JSE reported that foreigners last week were net buyers of R612-million worth of SA stocks. This amount excludes unfathomably large transactions that take place in murky waters that you and I don't know about.

The JSE, like its counterparts around the world, wants a hand in the business and is in the process of setting up its own facility to deal with dark-pool transactions. Whether dealers will prefer to stay in the shadows or not will be answered in due course, no doubt.

It has been a busy time on the stock market. The JSE has in recent weeks recorded successive record levels of volume. Apart from dark pools, the biggest talking point has been automated trading, in which so-called "black boxes" are programmed to buy and sell sometimes infinitesimal amounts in fractions of seconds.

Much of this trade comes from offshore, where automatons are uninterested in fundamental company analysis and forecasts. Rather, every blip on a company's stock exchange ticker is an opportunity for minute profits that eventually stack up into gigantic gains.

Goldman Sachs may be the most hated bank in the world - by everyone except its clients and shareholders. In the first quarter of the year, the company made money every single day from its trading operations. Not one losing day.

Much of that profit was made by faceless computers, racking up high-frequency buy and sell orders based on complex algorithms that are beyond the ken of the brightest human trader.

The downside, for stock exchanges, of automated trade has been a collapse in the size of open orders made by buyers and sellers. Computers don't need to make fat margins when they can transform a couple of cents here and there into mega-profits. The people at Peresys, a Johannesburg-based provider of trading technology, say that activity in the JSE in the past few weeks has been blinding - an inhuman flurry of orders no conventional trading desk would ever be able to generate.

So, the big orders are dealt with behind the scenes in dark, mysterious pools and lots of little ones by near-infallible algorithms run by mainframes at Goldman Sachs and the like.

Where does that leave you, kippie, trying to build your nest egg by trading on the JSE?