Most newbies to investment and trading stocks often cannot tell the difference between a direct access broker and the online broker. Traders make their comparison of brokers based on a cost analysis model on the products offered, but often do not realize that the products are not exactly the same.
An online broker often has a flat rate transaction pricing structure that is inclusive of commission and the exchange fees. It is often around the range of $5 to $10 USD per trade. The trading platform offered is web-based and but often requires the trader to have the latest browser plug-ins such as JAVA, Active X or Silverlight already installed on his computer in order to run. The trading application may deliver streaming real-time last bid or ask, level 1 market data or delayed quotes, and in most case is offered for FREE to the trader.
Pros
- FREE Trading application inclusive of market data which may be provided by the BATS Exchange or Direct Edge, who offer free displayed books.
- Flat rate transaction fee.
- Historical stock data and more comprehensive research material on companies.
- Streaming news media content.
- Designed to work over the internet regardless of internet speed or computer requirement.
Cons
- Requires a computer to have the latest browser plug-ins and may only work on one or two browsers, such as Internet Explorer, and not supportive of other browsers such as Chrome, Safari, Mozilla, Firefox, Opera and Camino.
- Trader are offered few destinations to place orders and often miss trading opportunities that are visible in the books. The orders may well likely to be sold to the highest bidder such as to Market Markers with sophisticated black-boxes.
- Quality of support is low with long hold time.
- They charge additional fees for sub-penny stocks.
- Some online brokers charge for the platform if the trader does not execute certain minimum monthly or quarterly transactions.
- Some online brokers charge maintenance, inactivity or service fees.
- Margin is restricted to 4-1 leverage intra-day and 2-1 overnight for marginable securities.
- Traders who trade at the online broker are disadvantaged. Executions are often slower since they are dependent on the internet and the trader’s browser speed to send information to the market. I often refer to these orders as the “blind flow” because of the blind-sight and handicapped disadvantage that the retail trader has trading on the online broker’s system.
Direct Access Brokers offer traders the ability to directly route orders to market markers, specialist such as NYSE floor brokers, dark pools, liquidity providers, other exchanges, and ECNs. The traders are given more advanced tools such as market scanners and the ability to see the full market depth. The platform offered will require the trader to install an application on his computer and run from the trader’s Program Files. The cost per trade is normally comparable with an online broker’s rate, but is often significantly cheaper on the commissions. For that reason, direct access brokers are very attractive to the more active and short-term investors such as day traders, high frequency traders, scalpers and momentum traders. These traders probably came from an online broker environment when they first started out in the industry, and once they developed a higher trading skill level and experience. They then upgraded to the direct access brokers. These are seasoned investors who are fully aware of the pitfalls and rewards in trading stocks, options and futures contracts. They treat trading as a business and are often addicted to the highs and lows of the market. Let’s examine the direct access brokers offers:
Pros
- They offer multiple choice of direct access routing capability. The best firms will have routing to every venue.
- The ability to apply complex strategies and build algorithms. The exchanges do have strategies that are geared to assist traders in having better fills ratio and sometimes lower routing cost. For example, NASDAQ offers the SOLV strategy allows clients to take advantage of removing from the BX and getting a .0014 rebate on that flow. SOLV also only routes at .0026 and removes from NASDAQ book at .0027.
- They provide access to liquidity providers and dark pools that also offer the client a better price execution, fill ratio and rebate for adding liquidity. For example Citi’s LAVA will rebate subscribers 0.002 for hidden orders that add liquidity with zero display.
- The direct access brokers will pass on exchange rebates to their most active clients. The online broker most often route the flow to a low cost exclusive destination which does not cost extra and is not often directly to an exchange. Clients who trade at the direct access broker get the advantage of benefiting from the widely adopted the taker-maker model that most exchanges offer.
- The trading platform provides the ability to execute transactions at a faster rate. A really good platform will have direct connectivity to the exchange matching engine. Thus explaining the definition of direct access trading.
- Direct Access brokers offers more competitive commission and transaction fees than the online broker. The cost per transaction can be as low as .0039 per share for stocks.
- Most trading platforms provide access to more in depth real-time market data such as NASDAQ’s Totalview, ARCA Book, NYSE OpenBook, BATS and Direct Edge Books. These are books which can assist the trader in making better trading decision on very active and heavily traded securities in real-time.
- They offer higher margin leverage than the standard 4-1. Some firms will offer portfolio margining leverage of 6.7-1 margin. And the proprietary direct access brokers will offer leverage around 20-1.
- They offer traders a choice of trading platforms. A shrewd broker will provide a choice of direct access platforms and an online system for the trader to trade on. The reality is that the active trader will jump around from broker to broker and it is an easy sale if the broker has the system he is already familiar with. Most traders attribute their trading success with the platform. The platform must have the tools they need to continue their strategy successfully.
- The level of Customer Service provided by the direct access broker is better than the online broker. Most online broker may or may not have a telephone number listed on their website and perhaps only provide messaging support. The direct access broker will have telephone, online live chat and e-mail.
Cons
- There is a higher technology cost. There is a cost to receiving in-depth market exchange data and additional routing fees to the Exchanges. And therefore the platforms are not offered as FREE.
- The platforms are downloadable and are often designed to work on Windows based operating system. It requires high-speed internet and often lost in connection can result in a bad trade.
- All orders are self-directed or unsolicited and most do not offer managed portfolio management. The direct access broker will not advise you on what to buy or when to sell.
- The risk factor is higher since the trader is dependent on the stability of the technology and the trader has only himself to blame when the trade is not favorable. The transactions are happening in milliseconds and there is always the risk of a “fat-finger” key trigger.
It is obvious that trading at the direct access broker provides an edge over the online broker. Traders get the advantage to better tools and are offered more values despite the few downsides and risk factor. But it is important to note that these firms are more geared to the more sophisticated investors. An individual trading as a professional will require special tools and is willing to buy the more robust equipment to ensure that his work is at a higher standard. He will spend his time testing and trading on different platforms to test speed, stability and functionality. He will do his research on which direct access broker will offer him the lowest commission, the most rebates and the best technology. He is also the same type of investor who will invest the time and research in knowing which securities to invest in.
But let’s not forget the kind of investor who would not be attracted to either the online or the direct access broker. This investor is the traditionalist who invests in safe instruments, low risk and none of what I discussed above would be remotely appealing to him. He would be someone who is not really concern about the cost of the trade or the tools needed to place the trade. He is interested in having his portfolio managed by a seasoned professional who he relies on for recommendation in growing his portfolio. This individual would see the services of the retail broker most valuable since he would rely on his broker to spend the time researching companies and managing his portfolio. The charge for this premium service is higher commission than both the online and direct access broker because the retail broker is taking the risk of advising his client of what to invest in. And believe it or not he may very well be using the very same tools that the direct access broker offers to traders.
Ask yourself: what kind of broker is right for you?
Are you someone who is looking to dabble in a couple trades per month?
Are you a Wall Street enthusiastic who jumps from firm to firm and always looking for better deals?
Are you someone who plays it safe?