Tuesday, October 27, 2009

Calling Out Matt Taibbi on Dark Pools

So, I wrote this explanation of the reality of dark pools earlier today.    Then, after having a few going away drinks with some friends, I read Taibbi's piece "Goldman Lobbies Senate, Says Full Transparency Sucks," which pretty much proved my point - that people railing against dark pools almost certainly don't understand what they are angry about.  Goldman Sachs put out a presentation attempting to explain to the ignorant masses on the internet how the markets actually work.  It's a pretty decent presentation, which ZeroHedge has an even better version of here.   

Now, let's get to Taibbi's analysis:  "One friend of mine put it this way: say Goldman buys a big block of stock from a pension fund in a dark pool. Now they have shares they want to get out of and flatten out their risk. So where do they sell? Well, a big chunk of it might go to the retail schmuck who has no idea what’s going on. He’s buying 1000 shares of whatever at $28, not knowing that Goldman has another 50,000 shares to go. Next thing you know, the schmuck’s shares are at $27."

You don't have to be a professional trader to understand why Taibbi's "friend's"  logic is batshit crazy.  In fact, I'd expect any intelligent journalist who endeavors to write financial articles with impact to understand this simple concept:  If you're Goldman Sachs, your business model is not, has never been, and never will be to buy large blocks of stock from pension funds in dark pools and then unload them on unsuspecting retail "schmucks" at lower prices.   Buying at $28, selling at $27.  Sounds like a barnburner business plan - sign me up! (/sarcsm).

There's an old allegory about the farmer who bought watermelons for $10 and sold them at market for $9.  His friend asked him, "How will you make money doing that?"  "VOLUME!"  He replied.

That's basically what Taibbi's suggestion is:  that Goldman Sachs is buying large blocks of stock from pension funds, and turning around and selling small pieces of these blocks to poor innocent retail investors, thus driving the price down.  Somehow, I guess Taibbi believes, GS will make up for it in volume! By the way - there is almost no reason for any retail investor to use dark pools - since retail investors don't need to worry about other traders acting on their visible supply and demand - because it's so small.

I went back and pulled another Taibbi quote on high frequency trading, just for the fun of it:

"The people who are actively innovating on Wall Street are all involved in the business of gaming the system to take advantage of short-term price swings. The people who invest money for the long-term and stick with their investments are punished in this environment."

Hey Taibbi - guess what - that was my point:  you've been complaining about high frequency traders scalping visible supply and demand, and now you're complaining about the antidote to such high frequency traders.  It  may make for good click bait among the ignorati (I just coined that word, and I love it) - but it doesn't make sense in the real world.  Pick your battle - hate one or the other - or even neither - but as long as you hate both, you're proving your ignorance.


ps - usual disclosures - I do not, and have never worked for or received any compensation from Goldman Sachs.


Anonymous said...

ignorati - it's either Italian or Latin - nice invention


Daniel said...

ignorati= ignorant Catholics?

Jr Deputy Accountant said...

Interesting analysis. Misplaced outrage is running rampant these days, not limited to the financial press I suppose.

Goldman is still diabolical though, right? Just checking.

Jesse said...

Your example of the trading that Taibbi's friend put forward was a misunderstanding of course, just based on common sense might have been the tipoff.

The notion he describes is goldman pays a lower "wholesale price kept dark" than 28 and then feeds it out at 28, and then that price later falls to the wholesale price of 27.

If you are going to diss someone who might deserve it, it usually helps to at least make at handwave at understanding what they are saying so you don't appear to be dismissive from ignoranze.

Kid Dynamite said...

come on Jesse - I thought you were aware on matters of markets. Maybe you need to read the Dark Pool Primer:

there's no such thing as "wholesale prices kept dark" the trades all hit the tape, and all happen at the inside market.