Direct Market Access and Market Maker Execution

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Direct Market Access and Market Maker Execution

Q.: What is a Direct Market Access equity CFD?

A: Direct Market Access (DMA) guarantees that you are trading on real market prices and liquidity. When a trader places a trade this is replicated in the underlying exchange before being offered to the speculator as a CFD. Market Makers on the other hand offer a market that may differ from the underlying exchange. In this case as soon as a client places an order to trade a share CFD the provider simultaneously creates the equivalent trade in the underlying cash market to hedge the exposure. This means that all client CFD trades are reflected exactly in the central exchange order book in terms of price and volume and you can actually see your limit orders appearing on Level 2 in real-time. This enables investors to trade SETS and SETSmm stocks directly with other market participants and so avoid the necessity of paying market maker spreads. Thus, DMA trading allows for more flexibility pursuit of the best bid/offer spreads which are particularly important when using leverage to trade (since small moves are magnified).

Note that DMA is mainly for shorter-term traders and DMA CFDS not only enhance transparency but also allow traders to participate in pre/post market auctions. This doesn't apply to quote-driven CFDs or spread betting.

Direct Market Access (DMA) empowers retail investors to fully interact with professional traders and other market participants, all in real time. It is a fast, efficient and transparent method of trading, allowing private investors for better control over their trading in liquid stocks and getting the execution they require, which can be particularly important in a fast-moving world.

Q.: What are Stock Auctions?

A: Share auctions are relevant to Direct Market Access trading. The opening auction is held between 7.50 and 8.00 and the closing auction takes place between 16:30 and 16.35. There can also be an auction during a trading day for various other reasons like a share going in auction for 5 minutes if it has moved by more than 10% (I think) - the idea is to stabilize the price a bit.

Note that the closing auction occurs in SETs stocks which are order driven. Between 16.20 and 16.30 the system will constantly compute every shares Volume Weighted Average Price (VWAP) which can used as the closing price of the day. The VWAP is used as with certain illiquid stocks small trades at the end of the day can manipulate the closing price. The auction then begins at 16.30 and further helps to prevent manipulation of share prices in highly illiquid stocks. At this point trades and orders can still be entered into the system and can be changed or deleted whilst the auction is open. The auction then reaches a random end point with the system calculating the uncrossing price with buy and sell orders (that are at best) being matched (same happens for buy and sell limits).

Of course there is nothing preventing you from placing a limit order above or below the true price (the last trades or the VWAP). In such cases your order will be filled depending on the other orders in the auction.

Q.: What is Market Maker Execution?

A: Market Makers are CFD brokers that quote a bid-offer spread and receive orders from clients which they then confirm with the trader. Market Makers (unlike DMA Brokers) do not automatically hedge the positions in the open market but instead use other methods to cover their exposure like offsetting trades against other traders, buying options, warrants or futures or even buying shares in the open market.

Markets Makers are not bound to follow the underlying market unlike DMA brokers - for instance if Marks & Spencer (LON: MKS) is trading with a bid-offer of 263.25 - 263.50, the Direct Market Access broker must follow these exact prices while market makers can specify their own quotes. Most of the times the market makers still follow the market depth but sometimes they add additional liquidity and trade more volume than exists as a price level. In this instance the DMA pricing model is more transparent and reflects exactly the price action in the underlying market.

Q.: What is the difference between a direct market access broker and a market maker provider?

A: Market Makers make their profit from the spread as opposed to Direct Market Access brokers who make their profit through the commission. Market Makers will follow the real market as closely as they can but it is important to note that they are not obliged to quote you the market price because by definition they are market makers and hence have the freedom to quote their own price.

Let's take an example of a stock trading at 150p-154p, an individual using a traditional brokerage company would have to either buy at the offer of 154p or sell at the bid of 150p. On a round trip trade of 10,000 shares this would cost the trader £400. On the other hand a trader with Direct Market Access who was trying to buy could enter an order with their own bid at 152p. This order would join the best priced orders at the top of the order book and thus would stand a good possibility of getting executed. DMA traders also have the advantage of being able to participate in the exchange's opening and closing auctions which often records a stock's high or low of the day and thus provides traders with a chance to get fills at optimal prices. The transparency of a DMA CFD broker is an advantage if you're day trading as you will be able to view exactly what is available in the markets.

Having said that the MiFID financial directive which most CFD providers have signed for obliges brokers to provide best execution. Sure, some market makers play games at times, and make it very hard to exit a trade or give too many re-quotes, freezing and such. But by large it has been an improvement over the past years, and I think this will continue as competition is increasing.

Not all CFD providers offer you Direct Market Access, and unsurprisingly, this level of access and functionality can carry some small premiums. Note also that index, forex and commodity CFDs are unavailable through direct market access, these products can only be traded with a market maker.

It is important to note that you can be successful whether trading direct market access or with a market maker and both have advantages - most people lose because they don't apply a basic trading discipline, whatever market they trade.

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