More stock trading is moving away from traditional public stock exchanges and into places called “dark pools.” These are private, electronic markets where investors buy and sell stocks without showing their orders to the public.
Even as dark pools have grown increasingly popular, a recent study from the University of Missouri suggests they may make public stock markets less transparent and increase the risk of sudden stock price crashes.
Dark pools allow buy and sell orders to be submitted and matched electronically without public visibility, and they offer lower transaction costs. Less-informed traders, who often trade strictly for liquidity reasons, such as converting shares to cash, often trade in dark pools where they receive lower transaction costs.
“A key reason uninformed trades are drawn to dark pools is the small but meaningful price advantage they offer,” Ken Shaw, professor of accounting at the Robert J. Trulaske, Sr. College of Business and author of the study, said. “Dark pools typically have narrower bid–ask spreads, which reduces transaction costs. For traders who are not concerned with information discovery or guaranteed price execution, these lower costs can be a strong incentive to trade in dark pools.”
In contrast, since orders are not guaranteed execution in dark pools, informed traders trade more frequently on public exchanges, where they can use their information advantage to make higher profits. As a result, the cost of trading on the public exchange increases.
This trader segmentation has an important implication for corporate disclosure.
“A key mechanism in public markets is that informed traders question management and seek to uncover information, which pressures firms to release both good and bad news,” Shaw said. “When informed trading on the public exchange becomes more costly, this disciplining force weakens, allowing management to withhold or hoard bad news for longer periods.”
The migration of uninformed trading to dark pools can slow the release of bad news that usually causes stock prices to drop, increasing the likelihood of sudden, dramatic price crashes when that information is eventually revealed, as shown by Shaw and researchers at Saint Louis University.
Link between dark pools and accounting manipulation
Shaw and co-authors also found that before a stock price crash, companies with significant dark pool trading were more likely to make unusual accounting adjustments. These adjustments allow managers to hide bad news longer by tweaking the numbers, making the company’s performance look better than it really is and postponing the moment when negative information becomes public.
“This suggests that accounting manipulation is being used by managers to hoard bad news,” Shaw said. “By smoothing earnings or masking underlying economic problems, managers can temporarily sustain the appearance of good firm performance.”
Shaw and his colleagues became interested in dark pools after the Securities and Exchange Commission began raising concerns about the potential risks of trading on anonymous electronic networks, which has increased over the past 10 to 15 years. For their study, the researchers used data from FINRA, a nongovernment, self-regulatory organization, and analyzed the market activities of a large sample of companies from 2014 to 2023.
Informed vs. uninformed investors
When investors trade on the New York Stock Exchange or NASDAQ, market makers — actual individuals or firms — facilitate trades by quoting bid and ask prices and standing ready to transact. Dark pools are less attractive to these informed traders because trading is fully electronic and anonymous, which makes trade execution uncertain — a trade is complete only when submitted bids and orders match.
For an informed trader, information loses value quickly, so execution risk is costly. As a result, informed traders are more likely to trade on organized exchanges, where execution is more reliable.
“Our argument is that when it becomes harder and more expensive to profit from private information, traders have less incentive to acquire it in the first place,” Shaw said. “As a result, less effort is devoted to uncovering firm-specific information.”
“Crashing in the Dark? Trading and Stock Price Crashes” was published in the Journal of Business Finance & Accounting . Co-authors are Bidisha Chakrabarty and Xu (Frank) Wang of Saint Louis University.
Journal of Business Finance & Accounting
Data/statistical analysis
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Crashing in the Dark? Dark Trading and Stock Price Crashes
21-Oct-2025
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