What is Direct Market Access (DMA)?

Direct Market Access (DMA) means that when you place a trade online, your order is sent directly to the stock exchange for execution. You may be surprised to discover that this is not how online trading always works, but in fact DMA has only been available for retail investors for a relatively short time. In many markets, the majority of brokers still don’t use it.

In the traditional way of placing a trade, you give an order to your broker by telephone or online and your broker then requests a quote for that order from a market maker. A market maker is a company that is equally ready to buy or sell a stock; it quotes both a bid price and an offer price at all times and hope to make a profit from the difference between the two. This difference is known as the bid/offer spread or bid/ask spread.

Brokers usually poll several market makers and present the best quote to you. That quote is then good for a fixed period of time – say 10 seconds – after which it expires.

This is known as a quote-driven market. You’re given a quote and decide whether to accept it. Historically, all markets worked like this, with the price you get for any stock ultimately coming down to what the market makers were prepared to offer. But technology changed all that – and even small investors can now see the difference.

How order-driven markets let you trade directly

With the rise of fully electronic trading in the 1990s, a new type of market developed – the order-driven market. Under this system, the exchange has an electronic order book to which participants submit the price they want to pay and the amount they are prepared to buy and sell. Those orders remain on the book until they are accepted or cancelled.

If one trader places an order to buy and another to sell at the same price, then the order book will match the two and a trade will take place. Alternatively, if someone places a order to buy or sell at the market price – rather than specifying a fixed price – they will be matched with the best price available in the order book.

Not all markets have moved across to this method. It only works when there is plenty of liquidity (plenty of people willing to buy and sell at any given point). Without that, you might well find it’s impossible to buy or sell when you want. So different systems are sometimes used for different types of stocks.

For example, on the London Stock Exchange, the biggest stocks trade solely through its electronic order book, Stock Exchange Electronic Trading System (SETS). The least liquid stocks trade through a system called Stock Exchange Automated Quotation system (SEAQ), which is solely driven by quotes from market makers. For those in between, the LSE has platforms called SETSmm and SETSqx which essentially combine an order book with added liquidity from market makers.

However, even where the underlying market is order-driven, most brokers don’t put your order into the order book. If you want to execute straight away, they give you a quote from a market maker. If you put in a limit order to be executed if the share passes a certain price, it goes into their systems and is executed by them through a market maker if the limit price is reached.

The advantages of DMA

However, if your broker offers direct market access, your order goes directly into the exchange’s order book. This means a subtle change in your relationship with the market – you go from accepting a quote to making an offer. You are now a price maker rather than a price taker.

DMA has a number of advantages over using market makers. These include:

  • Orders should be executed more quickly, since they don’t have to travel via an intermediary
  • You should be able to trade at a slightly better price, because the market maker doesn’t need to take their cut
  • There is less potential for human error, with someone at your broker or market maker making a mistake
  • Specific trading strategies can make use of DMA, mostly by giving the trader more control over how his order is executed
  • Since no broker representative is involved in placing the trade, direct market access also offers more anonymity – often attractive to institutional traders who would prefer nobody to know what they are buying or selling
  • Brokers have lower overheads, since all they are doing is allowing you to place trades through their computers, which makes it possible to charge lower fees

Those who care about getting the most out of these advantages make a distinction between true DMA and one-touch DMA. With true DMA, orders go straight to the exchange without any human intervention – just some automatic checks by the broker’s computer system. With one-touch DMA, someone at the broker has to press a button to authorise your order to be passed to the exchange.

Clearly, one-touch DMA can lose the speed and anonymity advantages of direct market access. But in some countries, regulators don’t permit true DMA – they may insist that a human has to check that the trader’s account has enough money or securities to cover the order.

They may add also other restrictions, such as requiring the order to be accompanied by a unique trading ID, which can obviously mean that the order is not anonymous on the order book. These restrictions are often specific to foreign investors and are common in a number of Asian markets such as South Korea and Taiwan.

DMA for retail investors

Most of this matters very little for an average retail investor. However, direct market access may get you a slightly better price than is available through a market maker and enable you to manage your orders slightly better. The combination of lower costs and higher volume has also helped to bring down broker commissions in some markets, such as the US.

Unless you’re a very active trader, the savings aren’t going to be huge. I wouldn’t pick a broker solely on the basis that it offers DMA. But it is always good to see firms rolling out DMA, since this should hopefully contribute to steadily falling brokerage costs and better, faster service.

The fact that a firm allows you to trade a market online does not automatically mean that it offers direct market access. At many multimarket online brokers, your order does not go to the exchange – instead it’s passed on to a market maker, which may be another part of the same firm or may be a third party.

In some cases, your broker will hand over to a local broker in the market you want to trade, who will then place the order with a market maker. Understandably, the more links there are in a change like this, the higher your trading costs will be.

So which brokers catering to retail investors offers DMA as part of their trading service? In the US, there are a number of providers who provide it for American exchanges. There are less in Europe, but you can usually find one or two brokers who will do it for major markets.

However, the number of providers who offer direct market access for multiple markets and assets is much smaller. The obvious ones that are globally available are Interactive Brokers and Saxo Bank, which both apparently employ DMA on all the exchanges that you can trade through their platform. iDealing offers DMA for the UK, France, Belgium and the Netherlands.

A number of other firms such as Barclays Stockbrokers use Saxo’s infrastructure for international trading and so also offer DMA. (However, Barclays does not offer DMA for the UK market, as the UK trading part of its service uses its in-house system.)

In Asia, at least two Singapore-based brokers say that some of the exchanges they offer online trade through direct market access. OCBC indicates you get DMA with the Australian Stock Exchange, Bursa Malaysia, Hong Kong Stock Exchange, Indonesia Stock Exchange, London Stock Exchange, Singapore Stock Exchange and three US exchanges (Amex, Nasdaq and the NYSE). DBS Vickers says that it offers DMA on the Hong Kong Stock Exchange, Singapore Stock Exchange, Toronto Stock Exchange and the three American exchanges.

Understanding DMA CFDs

In addition, several firms in the UK and Singapore are now offering DMA Contracts For Difference (CFDs). This is a slightly confusingly named concept, because it does not mean that you trade CFDs through DMA.

In fact, in most countries, CFDs are an over-the-counter product and hence there is no market to have direct access to. (The exception is Australia, where CFDs are listed.)

Rather, it means that you see a direct market access screen for the relevant shares, but when you trade in them you don’t actually buy or sell shares. Instead, you enter into a CFD with the provider at the price shown, which the provider can then hedge by placing a cash order into the order book on its own behalf.

This is a useful development for traders, since it means the CFD price is based on the underlying market price for a share rather than one quoted by the provider. This usually comes with slightly higher trading fees than non-DMA CFD trading services, but the tighter spreads should mean lower overall costs for very active traders.

However, this is a trading product. Investors should be aware of the difference between a firm offering direct market access for cash investment in shares and DMA CFDs, and not assume that just because a firm offers DMA CFDs that it also offer DMA for buying the underlying shares.