Online brokers are the most accessible and often the least expensive trading system available today. After all, they are available to virtually anyone with a credit card and an internet connection. But the problem with average, run-of-the-mill online brokers is that they suffer from atrociously slow order execution. In fact, novice traders who are serious about their profession will soon recognize speed can be a key factor in turning a profit. The system in which orders are placed and trades are executed is an essential tool for traders. Some of the easiest to use and most profitable for traders is called direct access trading (DAT) systems.
This article will provide an overview of DATs.
What are Direct Access Trading – DAT Systems?
Direct access trading systems allow traders to trade stock (or virtually any other financial instrument) directly with a market maker or specialist on the floor of the exchange, or immediate order execution. The system cuts out the need for a middleman, which you'll typically find in an online brokerage. The lack of a middleman can save a trader anywhere from several seconds to several minutes of time.
In trading, individual traders must compete against one another, whether they are novices or professionals employed large financial institutions. Professional traders will always have access to the latest and best tools and training, including the fastest buy and sell orders. So it makes sense for individual traders to have the absolute best system affordable in order to compete. Anything less can put them at a disadvantage when it comes to buying and selling orders.
But not all order execution systems are created equal. Even with all the existing direct access trading systems available, there is a range of speed and accuracy of execution as well as commissions charged for each trade. So traders must be careful to choose the system that meets their needs.
Let's take a detailed look at how certain features of particular DATs might meet a trader's individual style and needs. Note that this discussion refers specifically to stocks. Other financial instruments are traded using similar methods, but they may require slight modification in order to fall under the following general guidelines.
Level II Quotes
Since DATs cut out the middle man, traders can make connections directly to the markets, as long as they have an internet connection and a computer. This gives the trader more information and better chances of making a profit. That's because of something called a Level II format.
With a Level II screen, the trader can see a complete list of bid and ask prices as well as the order sizes for each stock in question. Before starting the trade, the trader will decide the price for the order — usually with just one click. The only thing left for the trader to do is decide the number of shares for the order.
That order size is entered into a pop-up window. Some systems allow a default value to be pasted automatically, which enables the trader to order, say, 1,000 shares without actually inputting the extra four keystrokes. Many traders will have a "typical" order size, and the default value can be a significant convenience and time saver.
Electronic Communication Networks – ECNs
Direct access trading systems also give traders the ability to trade on electronic communication networks (ECNs). The simplest way to describe an ECN is to think of a completely electronic stock exchange—buyers and sellers are matched by computer without the need for a human middleman. Orders are executed directly from the trader's DAT and transmitted electronically to the ECN almost instantaneously, sometimes within a fraction of a second.
Even if the order is not routed through an ECN, the direct access system also gives the trader direct access to market maker orders. Many of the orders floating around are placed by market makers either from their own firm's trading accounts or on behalf of their clients, which may often be large financial institutions. Surprisingly, online brokers may also be clients of market makers. These market makers may give online brokers a rebate for routing the market makers' trades—a practice called "payment for order flow".
This is another major advantage of using a DAT over an online broker. With an online broker, the trader has no influence over where the order is sent. By using a DAT, the trader can choose the market maker who will give the best price.
Fees and Commission
Some traders may be surprised to learn their DAT will cost them more than using an online broker. The higher cost of DATs comes from the probability that any online broker is receiving payment for order flow from the market maker, which allows online brokers to keep their commissions at rock-bottom rates.
Commissions for direct access trades, by contrast, are based on a scale which depends on the number of trades a trader executes over a given period of time. Commissions typically range from $15 to $25 per trade, plus an additional fee levied by the ECN. Total fees for each trade might then fall between $15 and $35. Finally, most DATs would levy a certain charge for the use of their software, which tends to fall between $250 and $300 per month. This charge is often waived if a trader makes a minimum number of trades, perhaps in the range of 50 to 300 trades per month. Obviously, the trader's choice among particular DATs should be made based on an overall consideration of cost, which must take personal levels of activity into consideration in this decision.
Pros and Cons of DATs
Active traders may find several benefits to using direct access trading systems. Here are a few of them:
- Speed: Trading is quick, which means there is no lag time. You can usually execute a trade within several milliseconds.
- Cost: Compared to retail brokers, DAT transaction fees are comparably low. While these costs under at DAT are usually per share, other brokers' fees may be higher because they typically charge per transaction.
- Liquidity rebates: Other brokers have a commission fee per trade because they sell order flows. DATs, by contrast, don't sell order flows and usually get rebates which are passed on to their customers.
But like everything else, there are some disadvantages to using these systems:
- Need for expertise: Novice traders may find it difficult navigating and wading through the systems at first. Making trade decisions and order routing requires a certain degree of expertise and knowledge, which may be costly in the beginning.
- Volume fees: Some systems require a minimum monthly trading volume. If that isn't met, it may charge the trader a fee. Traders should make sure they can meet the minimum trade requirements, if any, before signing up.
Popular DATs Platforms
Many online brokers offer traders access to direct access trading systems. Investors should do their own research to make sure the system they choose meets their individual needs.
Here is a list of some DATs available to traders:
- Trader Workstation from Interactive Brokers
- Thinkorswim from TD Ameritrade
- StreetSmart Edge from Charles Schwab
- Active Trader Pro from Fidelity
- DAS-PRO from DASINC
The Bottom Line
There are many DATS and ECNs out there. While many of these systems have now become well established among traders, the industry remains in constant flux. Today's systems may become "also-rans" in tomorrow's trading environment. So keep your options open when choosing your systems and never become married to a particular company or software program.
The best action as a trader is to maintain a backup plan in case your current way of doing business suddenly changes because of, say, system failure or the bankruptcy of your system provider. The smart trader is totally prepared for any situation and stands ready to turn on a dime if his or her way of doing business suddenly changes.