Direct access trading is a technology which allows stock traders to trade directly with market makers or specialists, rather than trading through stock brokers.[1]
Direct access trading systems use front-end trading software and high-speed computer links to stock exchanges such as NASDAQ, NYSE and the various Electronic Communications Networks. Direct access trading system transactions 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.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 are generally on a per share basis and typically around 0.005 USD per share. For example, the commission would be $8 for a 1000 share transaction at $0.008 per share.
Some firms set fee schedules instead of passing exchange fees on directly. This improves the transparency of fee administration. 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
Some firms do not charge their clients a platform fee. Instead, they provide a lower-end, less-featured trading platform to minimize their costs. More complex systems are offered as an upgrade option, but come with monthly fees. Costs can be recovered elsewhere, including hidden fees, or giving a client significantly less interest for cash balances.
Some firms have platform or software fees which 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.
[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 types 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. Some firms charge inactivity fees if a minimum monthly trading volume has not been met. For example Interactive Brokers charges a 10 USD per month inactivity fee on accounts generating less than 10 USD a month in commissions. Many firms will deduct transaction fees and commission paid each month from that month's inactivity fee. Hence an activity fee often serves as a minimum monthly commission which is paid to the brokerage. However, not all direct access trading brokerages charge an inactivity fee.
[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 to take care of themselves and make trade decisions on their own (without the help of brokers or advisors). These people typically include:
1. day traders - 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 profits, and even 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; the difference between success or failure may be determined in just a second. A delay of seconds to minutes, as is common in traditional online trading, would therefore not be acceptable to such traders.
4. momentum (technical-based) day or swing traders - they trade on high momentum stocks, in which it has high volatility. They need their orders executed lightning fast, and may need to get out quickly if the market goes against them.
Direct access trading is not typically for:
1. (long-term) investors - 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. Some direct-access brokers charge inactivity and platform fees. These costs may not justify direct access trading for long-term investors.
2. novice traders - Direct-access trading typically requires experience and knowledge.
3. inactive traders
[edit] Direct access brokerages VS online retail brokerages
[edit] Advantages
1. Speedy execution: It allows very fast execution, measured in terms of milliseconds
2. Cost reduction: Transaction costs are lower for trade executed with a direct access brokerage. Transaction costs are generally per share (ex. 0.004$ per share) where as retail brokerage forms charge on a per transaction basis (ex. 5$ per trade).
3. Slippage: Slippage is controlled at a minimal. Also it has a higher chance to execute at a better price when the market suddenly moves rapidly
4. Control over order routing: With most direct access firms, a 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] Disadvantages
1. Volume Requirement: Some firms charge inactivity fees if a minimum monthly trading volume has not been met. For example Interactive Brokers charges a 10 USD per month inactivity fee on accounts generating less than 10 USD a month in commissions. Many firms will deduct transaction fees and commission paid each month from that month's inactivity fee. Hence an activity fee often serves as a minimum monthly commission which is paid to the brokerage.
However not all direct access brokerages have minimum monthly trading volume requirements.
1. 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