Direct Market Access (DMA) has transformed the way in which shares are bought and sold but has only recently been made available to the retail investor community and a large number of brokers still don’t provide access to it. In this article, we examine why it has been such an important development, the advantages traders can accrue from having direct market access, and how one can go about acquiring direct market access in order to benefit their trading activity.
Trading Before Direct Market Access
To understand what Direct Market Access refers to you must firstly go back to how shares were traditionally bought and sold.
Traditionally, investors interested in buying shares would place trades through a system called SEAQ. Under this system, the investor buys and sells from the market maker (also known as the middle man) via their broker. Here, the middle man creates the market. Every market maker in a particular stock would post a two-way price, revealing the price at which the investor would buy or sell for a specified number of shares.
The main feature of this trading system is the guaranteed liquidity provided by market makers, guaranteeing two-way prices for the investor. This, however, exposes the market maker to a degree of risk and to shoulder such risk market makers take a cut on the trade. The cut they make equals the difference between the price they are willing to sell and the price they are willing to buy. This variation is known as the bid/offer spread or bid/ask spread.
Under a quote-driven market such as this, brokers would poll to different market makers and offer the best quote to the investor, meaning the price that the investor received for a stock would be subject to what the market makers proposed.
The Emergence of Direct Market Access
Introduced in 1997, SETS (Stock Exchange Electronic Trading Service) effectively cut out the need for such middleman. Under this trading system, the investor proposes the amount they are willing to pay to buy or sell, which is collated in an electronic order book where a system automatically matches up buyers and sellers.
So, for instance, rather than five market makers providing five bids and five offers for a particular security on SEAQ, for example, the SETS order book represents all registered offers and bids at a selection of different prices from whoever has access and a desire to transact, as orders can be placed by brokers, market makers, traders and private individuals directly.
Importantly, due to the fact that an automated market needs a large amount of liquidity passing through it to work effectively, only the biggest stocks are included as SETS stocks. Therefore, only the most heavily traded AIM shares feature on this trading system. As of 6th January, 2019, there are 157 AIM companies traded via SETS.
AIM stocks not deemed liquid enough to be traded on SETS are instead traded on a hybrid system, combining features from SEAQ and SETS, called SETSqx. Launching in 2007, this trading system is designed for securities with reasonable levels of liquidity, but which may at times require market maker quotes to maintain levels of trading. As such, the electronic order book is split into a quote book and an order book – the quote book being the listing of quotes by appointed market makers, and the order book being electronic orders entered as they are on SETS.
Under such a system, market makers provide continuous liquidity throughout the trading day, whilst order book execution takes place through auctions, with four uncrossing’s designed to concentrate liquidity. Both market makers and non-market makers can participate in these auctions meaning that SETSqx provides investors the opportunity to trade against market maker quotes, as well as by submitting orders into the auctions.
The Advantages of Direct Market Access
When compared to the quote-driven market provided by market makers, Direct Market Access offers a range of advantages for active traders. These include:
- Equality: Orders of equal status, prioritised in terms of time and price, are to be found in the order book.
- Market transparency: Orders are available to all market participants, allowing full contribution to the central market liquidity.
- Depth of order book: The order book reflects the number of buyers and sellers, as well as their trading price.
- Pricing: Orders can enter limit orders at their preferred price. These are then made available to the entire market.
- Tighter spreads: Market spreads become tighter by virtue of limit order being displayed publicly rather than privately. The order placer is benefited given that it provides a better chance of executing at an appropriate price. The benefit to the market is found in the provision of a tighter public reference price to work from.
- Poll: Highest and lowest prices often occur at the pre-market and post-market auctions. Participation in these is granted.
- Tranquility: Regulation and market supervision by the Exchange with no third-party involvement.
- Security: The order book remains available throughout the trading hours of the day.
Direct Market Access providers
With a number of notable advantages, then, how does an investor actually acquire direct market access? Well, nowadays, direct market access platforms are commonly available via brokers. A list of providers is as follows:
Type of Account
Fixed commission based pricing structure: 0.005% on the FTSE 100, key FX : 0.08 basis point
0.6 points on key FX to 1 point on the FTSE 100
on S&P 500, 0.6pip on Nasdaq 100 and FTSE 100
Getting setup with a DMA account
The preferred vehicle to open a DMA account is through one of the brokers stated above. This is a fairly smooth process, these will ask you to create an account with them, provide personal details such as proof of identity and contact details. This provides the investor with the ability to place orders directly on the LSE order books in the same route as institutional investors do. Some brokerage platforms will require an appropriate level of experience as they offer credit account. They will process a set of questions to determine the investor’s experience, credit assessment and suitability.
Main considerations when setting up a DMA account:
- Commission rates: if the investor is placing high volume trades there will usually be the possibility to rebate the online prices.
- Margins and leverage: when trading with a DMA provider, investors should get access to improved margin rates in comparison to retail investors. Comparing the DMA margin and DMA leverage rates in comparison to the exchange should act as a useful benchmark.
- Market access scope: not all brokers cover the same access to the market therefore it is important to check prior creating an account.
Direct Market Access offers a vast amount of advantages for active traders including speed of execution through placing high volume trades directly from the exchange book order – making this service more suitable and cost-effective for experienced investors, professionals and institutions. When trading on the market through DMA, the investor needs to pay great attention to their strategy. This is due to the speed of trading which may lead to human error or bugs in automated computer software, increasing the risk of losing money due to the leverage.
Please Note: This article is purely for informational purposes and reflects our thoughts on the stocks. None of the above should be construed as advice. As always, do your own research.