Comparing Direct Market Access to a Quote-Driven Service

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There are generally two types of CFDs. (CFDs offered by a Market Maker and CFDs offered via Direct Market Access).

DMA Order Flow		Market Maker Order Flow
Client Order DMA CFD Provider LSE		Client Order Market Maker CFD Provider DEALER

Direct Market Access (DMA)

DMA CFDs result in an order being passed directly through to the underlying physical market with no dealer or market maker intervention, resulting in real time execution and true market prices. DMA CFDs provide complete order transparency allowing clients so see their orders being hedged in the underlying market, join a bid or offer queue and participate into the opening and closing match out phases. When trading DMA CFDs you receive all the benefits of trading shares with the additional advantages that CFDs offer.

This means that orders are entered directly into the market in exactly the same way as you do through discount brokers with direct access to SEATS. You have the option of hitting the bid/offer, or you can join the buy/sell queue. This has the advantage of potentially getting an entry at a slightly lower price than is possible via a Market Maker. In highly volatile markets you should have the same chance of entry/exit as normal share traders. Of course, this is also dependent on the software platform that you are using.

Broadly speaking, there are two versions of the order book. Level 2 is the London Stock Exchange's most detailed data-feed and what professional traders use. If you want it, you will normally have to pay so make sure that it's worth your while. One complication is that Level 2 order books work differently, depending on the stock being traded, so you will need to understand the differences. FTSE 100 stocks trade on SETS, small stocks and Aim shares trade on SEAQ - using market makers - and most FTSE 250 stocks trade on SETSmm, a hybrid of SETS and SEAQ.

A major obstacle to DMA trading is the cost of Level 2 data (the live order book). At present, the LSE charges private investors around £30 a month for the full Level 2 data feed. Note that guaranteed stop-losses are not available with Direct Market Access so you must have the time to watch the markets for hours on end if need be and wait for the right moment. This means that Direct Market Access dealing is best suited for frequent traders (5 times a week or more).

Direct Market Providers will usually charge a higher brokerage than for Spread Providers, but the Spread itself may exceed the difference in brokerage.

Market Maker

Market Maker CFDs are not directly hedged in the underlying physical market; instead it remains the discretion of a dealer or market marker as to whether they hedge CFD position in the underlying market. As it is up to the discretion of the Market Maker as to whether CFD positions are hedged the provider can be exposed to a significant amount of market risk. This model results in slow order execution and lacks transparency as individual client hedge orders are not directly entered into the physical market. The queuing system is at the discretion of the CFD provider. Furthermore, Market Maker CFD providers are unable to provide partial fills, and will typically only fill client orders once the bid price reaches the offer price or offer price meets the bid price which means that you may be forced to pay a higher price when purchasing or a receive a lower price when selling.

The CFD provider controls the price that is offered. This price and depth usually mirrors the underlying market, but this is not guaranteed. Market Makers add an additional layer into the dealing process which could result in orders not being processed due to the Market Maker process in highly volatile markets.

My understanding is that that to buy there must be stock offered, and to sell there must be stock bid. In other words you must sell at the bid, and buy at the offer. You can not take part in the open and close auctions on the London Stock Exchange.

Let's briefly explain the two models that have been adopted by CFD providers.

Direct Market Access:

Market Maker:

Let's consider what would happen if one of these Market Makers gave you a fill on a trade that was just 1 pence (£0.01) worse than that available in the physical (and therefore DMA) market, whether it be due to slippage or a requote. Often, this small amount of slippage would be tolerated by clients but the truth is it will often completely erode any benefit the trader may gain by saving a few pence on up-front brokerage.

How common are slippage and price requotes? Obviously it varies, but it is not at all uncommon for those using the Market Maker model to be given a requote with only seconds to decide whether or not to accept the requote before it expires and a new requote must be requested. This is considered a normal part of trading for those using platforms based on the Market Maker model.

The model used by your CFD provider is also important when it comes to the execution of stop loss orders. The Market Maker model will usually involve a dealer (working for the Market Maker) choosing the price at which your entire stop loss order will be filled. If your position was not laid-off in the market by the Market Maker it will be in their interests to give you a less than optimal fill. Using the Direct Market Access model, your stop loss will be filled at the best available price once the stop has been triggered. This may result in slippage but this risk can be overcome through the use of Guaranteed Stop Loss Orders.