Direct access trading

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Direct access trading is a technology in which a client can trade directly to the special people at the exchange, without any brokerage interference with your orders. The special people refer to market makers or specialists who trade with you directly on the floor of an exchange.

Contents

[edit] Operation

Direct access trading system uses front-end trading software and high-speed computer linkages to different exchanges like NASDAQ, NYSE and the various Electronic Communications Networks

As this technology bypasses the need to pass orders through to brokerage firms and re-route them to the market, orders are executed in a fraction of a second and their confirmations are instantly displayed on the trader's computer screen. This is in contrast to a typical conventional online trader who requires seconds or minutes to execute a trade.

[edit] Commissions and fees

[edit] Commission

Most direct-access firms charge commissions based on your trading volume, usually in terms of calendar months. The more you trade, the cheaper you get. It can be as cheap as you can trade by 1 point or pip difference, in that it is a must for scalpers.

Unlike traditional online brokerages, direct-access brokerages usually pass through the exchange fees involved in trading to customers. Examples are specialist fees, Electronic Communications Networks fees, exchange modify and cancel fees, clearing fees, regulatory fees etc. Commissions typically range from $10 to $15 for a 1000 share transaction. Sometimes they do not pass through the whole costs directly. Instead they set one's own fee schedules to cover costs partly (or make profits after costs are covered). Apart from profit making, they are here for easy administration too. For example, you do not need to change the charge any time there is a change in the exchange fees. Some fees may be complex to calculate or variable. It is not easy to write them on the fee schedules.

[edit] Platform or Software fee

Fees are usually required to cover firms' costs of developing, using and maintaining their proprietary trading software or platforms. The charge can be somewhere between $50 to $300 per calendar month. However, most firms will waive the fee if you trade up to a specific volume per calendar month.

Some do not charge any platform fee. However there is no free lunch in the world. They either give to lower-end trading platform to minimize their costs (they would normally offer another plan with front-end trading platforms, but monthly charges being present), or cover their costs elsewhere (eg by having some other hidden fees, or giving you significant less interests for cash balances).

[edit] Account minimums

There are usually 2 types of minimums to open a direct-access account.

The first one is balance minimums. This could be several thousands in USD. Different type of accounts may have different requirements. More deposits are required if one engages in pattern day trading according to US regulations.

The second one is activity minimums. Direct-access firms may require the client to have some minimum trade activity, or an inactivity fee will be charged.

[edit] Who uses direct access trading?

Direct access trading is primarily for self-helped and active traders who value speed of execution and try hard to minimize costs and slippage. Also they get take care of themselves and make trade decisions on their own (without the helps of brokers or advisors). These people typically include:

  1. daytraders - they trade a lot per trading day. Direct access brokers can give them front-end trading software and platforms and offer deep discounts on commissions and brokerage fees.
  2. scalpers - they trade in a large volume for small gains. Slow execution may kill all of the profits (and incur losses).
  3. momentum (event-based) traders - their trading decisions based on news or incidents happened in normal trading days. When the news breaks out, the market will usually become very volatile. They need lightning fast execution to enable them to grasp these opportunities, whether success or failure may be determined in just a second. A delay of seconds to minutes in traditional online trading is definitely not acceptable.
  4. momentum (technical-based) day or swing traders - they trade on highly momentum stocks, in which it has high volatility. They need their orders executed lightning fast, or get out quickly when something goes against them.

Direct access trading is not typically for:

  1. (long-term) investors - while the slippage is important to frequent traders, but it amounts to only a dollar or so for each trade. They hold a position for a long time. Each trade may earn them substantial profits to cover those small slippage losses. Traditionally direct-access brokers will charge for inactivity charges and platform fees. This costs are not justified the use of direct access trading for long-term investors.
  2. novice traders - Direct-access trading typically requires experience and knowledge.
  3. inactive traders

[edit] Direct access trading VS traditional online trading

[edit] Advantages

  1. Speedy execution: It allows very fast execution, measured in terms of milliseconds
  2. Cost reduction: Slippage is controlled at a minimal. Also it has a higher chance to execute at a better price when the market suddenly moves rapidly
  3. Advanced Platform:
  4. Control over order routing: Although most direct access firms an active trader may choose to send his orders to any specific market maker, specialist, or Electronic Communications Network
  5. Liquidity rebates: Traditional online brokerages usually have a simple and flat commission fee per trade because they sell order flows. Direct-access brokerages do not sell order flows and get rebates They earn money from serving their customers. An active trader can gain what traditional online brokerages gain

[edit] Disadvantage

  1. Volume Requirement: You need to trade actively or the costs will not justify you to direct access trade
  2. Knowledge: New and inexperienced traders may find it difficult to be familiar with direct access trading.

Knowledge is required when dealing with something like making trade decisions & order routing

[edit] Notes and References

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