Direct Market Access Vs Market Maker
Retail and institutional investors are able to trade leveraged products such as options and Contracts for Difference (CFDs) on Shares (equities), indexes, commodities and currencies with a bewildering variety of brokers, exchanges and providers. Most CFD traders want a single point of access to several different equity markets worldwide and to be able to trade under conditions of anonymity. Furthermore they want an efficient, neutral service that offer clear benefits in terms of speed, market access, control over trades and most importantly value for money.
There are two main types of providers of these services:
- The Direct Market Access platform model (Such as stock brokers, Option brokers - as opposed to the option Market Maker - and some CFD providers) and the other is;
- The Market Maker platform model (some CFD Providers, financial spread betting providers). Follow this link to read more about option brokers and the role of the option market makers .
As a trader or potential trader in the stockmarket it is essential understand their differences. More specifically, as a trader you must understand and compare the fee structure associated with both, because it's the fees that you pay that can eat up your profits or worse, increase your loss.
We will take out brokers from the following comparisons as they trade directly into the exchanges (i.e. equity, options and futures exchanges) and instead concentrate on CFD trading with CFD providers who are over the counter (OTC) derivative providers.
It is important to note that we do not intend to go into detail about ASX CFD's as they are too confusing to trade. Despite assurances from the exchange that they accurately reflect the price of the underlying security we have reservations about the ability of the market makers to provide a price in times of market stress.
Direct Market Access (DMA) Model
DMA CFD trading platform mirrors the prices and liquidity that are present within the exchange (i.e. the Australian Securities exchange or ASX), however, in very limited circumstances a CFD Trader may find the DMA Price may not match the prices on the underlying exchange, hence it is very important to read the Product Disclosure Statement (PDS) for the CFD provider to find out when this may occur.
With the DMA CFD provider model, there should be:
- no additional spreads;
- straight through processing;
- potential to be a price taker or maker, and;
- the ability to participate in opening and closing market auctions.
DMA providers, in theory, should make no profit directly from performance of the client who is CFD trading, as most have a 100% hedging methodology. This means that if you buy the CFD, the provider will instantly buy the underlying equity.
Market Maker (MM) CFD provider model:
- doesn't always have the same prices as the exchange,
- there is potential for additional spreads and potential requotes
- Market makers are price takers only,
- generally there is no participation in opening and closing market auctions and
- as they have an alternative hedging methodology, there is the likelihood that they will profit directly from the performance of a clients position.
Market makers do have some advantages over DMA whereas they can provide quotes on stocks that may otherwise be illiquid or potentially compensate for a lack of market depth at a particular price. They also have the ability to allow the trader to gain exposure to a wide range of exotic markets.
Whilst CFD trading, you may receive requotes on your CFD orders from a market maker CFD provider, this is the market maker adjusting their books to allow for internal hedging and also to compensate for a lack of market depth at a particular price and therfore get your order filled at the price shown and therefore get your order filled at the price shown. However the MM brokerage rate may be lower which could compensate for the cost of the spread.
When comparing the two:
One of the most important consideration to the trader is the cost to use their respective products. A couple of years ago the difference in brokerage rates between Direct Market Access and Market Maker models would have pushed the CFD trader towards the Market Makers, however many Direct Market Maker CFD providers have lowered their brokerage rates.
Now is the time to reconsider your brokerage costs on your returns. Firstly, check the commission to enter and exit a CFD trading strategy and with respect to market makers, how much difference is there between the actual ASX price and spread compared to the price and spread offered by the market maker. There is no point in accepting cheaper "headline" brokerage commissions with the Market Maker CFD providers if the spreads they offer, or the requotes, increase the cost of your CFD trading.
