What is anonymous trading?
Some investors have their reasons why they would not want to disclose their identity during a trade. High-profile and sophisticated traders almost always do anonymous trading. They want to trade those that we can see in the order book, but they do not want their identity known because they do not want everyone to know they participated in the market. Several stock exchanges allow this kind of trading to give privacy to people who wish to keep their trading to themselves. For instance, we have London and Toronto Stock exchange. We also have some that are pretty familiar to us: the Nasdaq and the New York Stock Exchange. Several dark pools allow the big shot people to trade anonymously.
But why is there a need to trade anonymously?
While most of us do not mind trading non-anonymously, some are not comfortable with that idea. As we mentioned, these people are usually the hotshots. And if everyone knew what the hotshots were doing and which stocks they were trading, would it not disrupt the market? If many people knew, it could lead to a front running behavior for the best position in the order book.
If this does not sound too clear, let us explain more. Let us say that a high profile is interested in buying millions of shares. So, he does not want anyone to know his plans before he even makes them a reality. High-profile people are not who they are if they do not know what they are doing. At least, most of them tend to make the right decision regarding investments; that’s why they multiply their money. So, if people knew what these successful people want to do, wouldn’t they try to imitate their actions? Smaller investors may bid up the price as they hope to sell it to high-profile investors for an easy arbitrage profit. Or else, pennying may be used to gain execution priority, and that is unfair.
What is pennying?
Pennying is an action that traders do when they raise the bid by a penny. This is cutting in front of a trader who was first in bidding a penny lower. These people do so when they know that another entity is willing and interested in buying a massive stock. Hence, they can raise the price and earn with that price increment. They know that the other entity will buy, no matter what.
Where can we encounter anonymous trading?
Anonymous trading is not as uncommon as it seems to be. However, it usually happens on three venues: anonymous exchanges, dark pools, and IDB or inter-dealer brokers. Giant stock exchanges cater to anonymous trading when they access the central order book because they compete with ECNs, which also offer anonymous trading. Other stock exchanges provide a hybrid trading system with automated anonymous order and non-anonymous auction order executions. Dark pools are private asset exchanges that give people more liquidity and anonymity to trade securities away from the public massively. Finally, we also have IDBs who work as middlemen for institutional clients in listed and over-the-counter markets.