Direct Access Trading Systems
Online Stock Trading is something you might know about. But even if you don't it's important to know how it works, and what the different terms mean, so that when someone asks you, at least you'll have a working knowledge of it to have an educated conversation. Everything in business runs on technology these days.
Online brokers are the most accessible, and often least expensive, trading system available today; after all, they are available to virtually anyone with a credit card and an internet connection. The problem with average, run-of-the-mill online brokers, however, is that they suffer from atrociously slow order execution. In fact, novice traders who are serious about their profession will soon recognize that 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. This article will provide an overview of direct access trading systems (DATs).
By the nature of the business, the individual trader must compete against all of his or her fellow traders, whether they are individuals or professional traders employed by North America's largest financial institutions. Obviously, professional traders will always have access to the latest and best tools and training, including the fastest buy and sell orders. Therefore, individual traders need the absolute best system that they can afford in order to compete - anything less can put them at an immediate and perpetual disadvantage in respect to buy and sell orders.
The difference between the professional trader's order system and an online broker is that the trader's system eliminates the middleman (the human broker). Direct access trading systems allow traders to trade stock (or virtually any other financial instrument) directly with a market maker or a specialist on the floor of the exchange, or immediate order execution. The absence of a middleman can save a trader several seconds to several minutes of time. (For more on this, see Understanding Order Execution and Brokers And Online Trading Tutorial.)
Understanding Order Execution
http://www.investopedia.com/articles/01/022801.asp
Despite the inherent advantage of DATs as compared to lower level systems, not all order execution systems are created equal. Even amongst all of the existing direct access trading systems, there is considerable variety in speed and accuracy of execution, as well as in the commission price charged for each trade. As a result, traders must be careful to choose the system that most closely approximates their needs in terms of speed, performance and price.
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
With a Level II screen, the trader will be able, for each individual stock that he or she is watching, to see a complete list of bid and ask prices at a single glance, as well as the sizes of these orders. The trader will decide at which price the order will be placed and needs to click only once on that price in order to commence the trade. The only other decision the trader will then have to make is the number of shares for the order. The order size is entered in a window that pops up on the DAT immediately after the chosen price is clicked on. Some direct access systems allow a default value to be pasted automatically into this space, thereby enabling 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 the 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 - within a fraction of a second. (To learn more, check out Electronic Trading Tutorial.)
Market Makers
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 on quote screens everywhere are placed by market makers, either from their own firm's trading accounts or on behalf of their clients, who are often large financial institutions. Surprisingly, online brokers may also be clients of market makers; certain 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. (For further reading, see What's the difference between a Nasdaq market maker and a NYSE specialist?
Fees and Commissions
Some traders may be surprised to learn that 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 that 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 should the trader place his or her order with an 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 tend 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. (To read more, check out Don't Let Brokerage Fees Undermine Your Returns.)
There are many DATS and ECNs out there, but while many of these systems have now become well established (and preferred) amongst traders everywhere, the industry remains in constant flux; today's systems of choice 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. Your best action as a trader is to maintain a backup plan in case your current way of doing business suddenly changes because of, say, a system failure or the bankruptcy of your system provider. The smart trader is utterly prepared for any eventuality and stands ready to turn on a dime if his or her way of doing business suddenly changes
Definitions:
Floor Broker (FB) ? Direct Access Trading - DAT ? Floor Broker (FB) ? Specialist ? Write Out ? Give Up ? Discretionary Account ? Agency Broker ? Intermarket Trading System - ITS ? Limit Order Book ? Specialist Unit
Floor Broker (FB)
An independent member of an exchange who is authorized to execute trades on the exchange floor on behalf of clients. A floor broker is a middleman who acts as an agent for clients, indirectly giving them the best access possible to the exchange floor. A floor broker s clients typically include institutions and wealthy people such as financial-service firms, pension funds, mutual funds, high net worth individuals and traders. A floor broker s primary responsibility is best execution of client orders, and to achieve this objective, he or she must continuously assess myriad factors including market information, market conditions, prices and orders.
Also known as pit broker.
BREAKING DOWN 'Floor Broker (FB)'
Once a floor broker receives a buy or sell order for a specific stock, he or she will attempt to get the most competitive market rate for the client. The floor broker does this by proceeding to the trading post on the exchange floor, where the specialist for the stock is located, and bids against other brokers and traders to get the best price for the stock purchase or sale. Upon completing the transaction, the floor broker notifies the client through the client s registered representative.
Specialist
A specialist is a member of a stock exchange who acts as the market maker to facilitate the trading of a given stock. The specialist holds an inventory of the stock, posts the bid and ask prices, manages limit orders and executes trades. If there is a large shift in demand on the buy or sell side, the specialist steps in and sells off his own inventory as a way to manage large movements and to meet the demand until the gap between supply and demand narrows.
BREAKING DOWN 'Specialist'
Most specialists trade five to 10 stocks at a time on any given trading day. There is usually one specialist per stock who stands ready to step in and buy or sell as many shares as needed to ensure a fair and orderly market in that security. Each specialist has a particular spot on the floor of the exchange, called a trading post, where the buying and selling of stock occurs. Floor traders, who act on behalf of customers who buy and sell stock, gather around a specialist's trading post to learn the best bid and ask offers for a security or stock. Specialists execute a trade when bid and ask orders match.
Write Out
A dual trade transaction enacted by a specialist in an individual stock issue. The first trade in a write out will be between the specialist and a floor trader, using the specialist's own inventory of stock, which is sold to the trader. The trader then executes the second part of the trade by transacting the same number of shares with an end client or firm.
BREAKING DOWN 'Write Out'
Specialists are given daily inventories of stock to use as they see fit to maintain an orderly market in the stocks in which they make markets. By stepping in to purchase or sell shares as needed, they can ensure a smooth and orderly market, even during rocky trading days. The advent of electronic trading platforms has limited the need for specialists and write outs, but so far, machines have not completely erased the need for people on the trading floor.
Give Up
Give up is a procedure in securities or commodities trading where the executing broker places a trade on behalf of a second broker as if the second broker actually executed the trade. This is usually done because a broker cannot place a trade for a client based on other workplace obligations. To ensure the trade is executed in a timely fashion, a request is made of another broker to place the trade on behalf of the first broker.
BREAKING DOWN 'Give Up'
On the record books, the trade shows the information for the client's broker, not the executing broker. Thus, the broker of the client and the broker on the other side of the trade receive the commission, while the executing trader gets nothing. The process is referred to as a give up because the trader who executes the trade gives up the associated credit for the purchase or sale; the executing trader also gives up the associated commission.
The act of performing a trade in the name of another broker is generally considered a professional courtesy. In regards to the reimbursement of a broker for services rendered, the payment of services associated with a give up functions within an area that is not clearly defined.
Discretionary Account
A discretionary account is an investment account that allows a broker to buy and sell securities without the client's consent. The client must sign a discretionary disclosure with the broker as documentation of the client's consent. A discretionary account is sometimes referred to as a managed account; many brokerage houses require client minimums (such as $250,000) to be eligible for this service.
BREAKING DOWN 'Discretionary Account'
Depending on the specific agreement between investor and broker, the broker may have a varying degree of latitude with a discretionary account. The client may set parameters regarding trading in the account. For example, a client might only permit investments in blue-chip stocks. An investor who favors socially responsible investing may forbid the broker from investing in tobacco company stock or in companies with poor environmental records. An investor might instruct the broker to maintain a specific ratio of stocks to bonds but permit the broker freedom to invest within these asset classes as the broker sees fit.
Advantages of Discretionary Accounts
The first advantage of a discretionary account is convenience. Assuming that the client trusts the broker's advice, providing the broker latitude to execute trades at will saves the client the time it takes to communicate with the broker before each potential trade. For a client who trusts his broker but is hesitant to hand the reins over in full, this is where setting parameters and guidelines comes into play.
Agency Broker
A broker that acts as an agent to its clients. When acting as the agent, the agency broker must look after its clients' best interests, which involves attempting to fill client orders at the lowest price and in the fastest way possible. Common clients of an agency broker include large institutional funds that place large block orders.
BREAKING DOWN 'Agency Broker'
An agency broker is a broker that acts as a middle man to the stock exchange, and places trades on behalf of clients. This is in direct contrast to broker-dealers, who purchase orders from clients and then sell these blocks into the market. Special care must be taken when using any broker, as there may be hidden fees associated with placing trades.
Intermarket Trading System - ITS
An electronic computer system that joins the trading floors of all the major equity American exchanges. This system essentially allows all eligible member market-makers and brokers the ability to execute buy and/or sell orders at different exchanges whenever they see that a better price quote available.
The system has connections with large national exchanges, such as the NYSE, as well as smaller regional exchanges, such as the Boston stock exchange.
BREAKING DOWN 'Intermarket Trading System - ITS'
Since the ITS was first initiated during 1978, some parties, such as the Nasdaq, believe the technology used in the ITS is now outdated. Moreover, the current trend for exchanges is moving away the trading floors that the ITS is based on and toward automated trading systems.
Limit Order Book
A record of unexecuted limit orders maintained by the specialist.
BREAKING DOWN 'Limit Order Book'
The specialist has the responsibility to guarantee that the top priority order is executed before other orders in the book, and before other orders at an equal or worse price held or submitted by other traders on the floor (floor brokers, market makers, etc).
Video Definition
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http://www.investopedia.com/terms/l/limitorderbook.asp
Specialist Unit
A group of firms or individuals that act as a market maker for one or many stocks trading on an exchange. A specialist unit maintains a stable market in a given security by acting as both a principal and agent for brokers. As a principal, a specialist unit will hold its own inventory of stock, in order to facilitate liquidity for a given trade.
BREAKING DOWN 'Specialist Unit'
Specialist units are also responsible for posting relatively narrow bid-ask spreads to maintain liquidity, managing limit orders and large block orders. Additionally, a specialist unit will act as a form of balance in the market by taking the opposing side of bullish or bearish sentiment for a given stock by trading out of its own inventory
Here's more information about:
"Direct Access Trading Systems"
Direct-access trading
https://en.wikipedia.org/wiki/Direct-access_trading
DIRECT ACCESS TRADING
http://www.tradingacademy.com/resources/financial-education-center/direct-access-trading.aspx
Direct Access Broker - Advantages & Disadvantages
http://www.extraordinaryinvestor.com/direct-access-broker.html
CHOOSE A DIRECT ACCESS BROKERAGE FIRM FOR DAY TRADING
http://www.dummies.com/personal-finance/investing/day-trading/choose-a-direct-access-brokerage-firm-for-day-trading/
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