The term Direct Market Access is used often in the industry and yet a lot of people do not know what it means or indeed how to use it. The term, in fact, relates to the use of the order book, a system used by market participants to trade directly with each other by inputting their sale and buy orders and waiting until they match. The system is more commonly referred to as Level 2.
The first major benefit of using Level 2 is that it is the main mechanism used by the market to trade. It is used by all of the major traders such as institutional investors, hedge fund s, and private individuals. Its benefits are significant as it enables market participants to buy at the bid and sell at the offer price. Consider the following example which is a screen print taken of the Level 2 screen for Carnival Corporation towards the end of last year.
(see attachment)
Before I go into more in-depth analysis I will briefly explain what the information displayed on the screen means:
* On the left hand side are shown the willing buyers of the stock, the number of shares they want and the price they are willing to pay (which is known as the bid price).
* The right hand side shows the number of willing sellers, how many shares they have to sell and the prices they want for their stock (the offer price).
* The yellow strip shows the keenest prices that are close to being filled. In this instance we have one person or institution that wants to buy 500 shares at £29.88 and three willing sellers with a total of 1,857 shares that they want to sell at £29.90.
Normally Carnival can trade with quite a wide spread, but on this occasion you can see that it is only two pence. So what does this mean if you want to buy the stock? With Direct market access you have two options and we will assume that you only want to buy one thousand shares. With the quote standing as it is, there are three different sellers who are willing to sell a total of 1,857 shares at a price of £29.90. If you were willing to pay this price and are fast enough in using the system it would be possible to buy your 1,000 shares now at £29.90.
Another option is that you want to pay £29.89, and by completing an order on the system your entry would change the quote on the yellow strip to £29.89 - £29.90, showing your willingness to buy at this level and all you now need to do is wait until someone comes along that is willing to sell at this level. Of course this is not your only option, you could input any lower price that you would like to buy at, but it will mean that your order will not be filled until those above who are willing to pay a higher price have their orders completed.
We have considered buying some stock, but what about selling? As you would guess, the exact opposite happens. The orders on the right hand side show the number of willing sellers and the prices and volume they want to sell at. Now if you were selling 1,000 shares there are again several options available to you. If you wanted to receive a price of £29.88, there is one individual who is a willing buyer of 500 shares at this level. If you input an order to sell 1,000 shares at £29.88, this would mean you are left with a balance of 500 shares to sell and the quote on the yellow strip would change to £29.87 - £29.88 showing the 500 shares you have left to sell at £29.88 and you would have to wait until a willing buyer came along who wanted 500 shares at this price. It could be that other sellers could come along wanting a lower price than you and this could push the price down further leaving you with 500 shares unsold.
A second option would be to sell the 1,000 shares at the best price possible. The Level 2 system would then take the 500 shares on offer at £29.88 and sell the remaining balance at £29.87.You will see from the system that after the £29.88 level, there are 5 willing buyers of 2883 shares at £29.87, so there is more than sufficient demand to take your remaining 500 shares at £29.87. This would therefore give you an average price of £29.875 for the whole 1,000 shares. It could be that you want to sell at a much higher level of say £28.93 and in which case your order would sit on the right hand side of the book waiting to be filled. Until a willing buyer comes along your order will remain on the Level 2 system.
You can see from the quote for Carnival the depth of the order book which at this moment in time was not very deep. There were not that many buyers around so it would not have taken much selling volume to push the price down. This is something that you will learn to spot with experience and different stock prices will behave in different ways. Early in the morning when the order book is still getting up and running, volume can be quite thin and there is sometimes an opportunity for bargain hunting. A stock such as Carnival is very interesting to watch and can be very volatile because it is a high priced stock that can move on low volume. You can see just from this example how hedge funds could potentially move a stock price very quickly. The number of buyers at this moment was quite small and it would not have taken much short selling to push the price down especially if any negative news were to be announced.
Be Careful!
When using the order book be very careful when typing in your order. The order book is the market and any error inputting your requirements can be quite costly and very difficult to amend. For example, the simple error of typing in a price that you are willing to pay which is much higher than the current price may result in you paying a much higher average price than you should have done and this would be almost impossible to undo. Also be very careful with typing in the quantity, this is another area for making a silly mistake which will be very difficult to unwind.
Partial Fills
This is an important factor to consider. If, for example, you placed an order to sell your 1,000 Carnival at £29.90, but only 500 were sold before the price fell, you will have paid commission on a partial sale at that level, but if you were to amend the price to a lower level at which you were willing to sell the remaining holding, this will be considered to be a new order and you will pay a second lot of commission. If you are dealing in a sizeable amount, the impact of this will not be so great, but it will add up for smaller trades. The answer is to watch the market very carefully to ensure that you get the price you want for all of your stock.
Quote Driven Alternative
The alternative to using Level 2 is a quote driven system. This is basically as it says a pure quote without any details about market depth as you get with Level 2. All brokerages will operate some form of quote driven system based on the underlying market quote derived from what is happening on the Level 2 system. What you have to be very careful of is that because you are deemed to be an intermediate customer, the brokerage is not obligated to give best execution which basically means that the quote they offer to you may differ fractionally from the underlying market. This means that, for example, British Airways could be quoted at £2.05 to £2.06 in the market, but a quote driven system may offer you £2.0475 to £2.0625, the broker then keeps the difference.
This is why some brokers will offer a deal for free service. The reason it is free is that the broker has increased the spread around the underlying market price which enables them to make a profit on your transaction without having to charge commission. It always pays to find out exactly how your broker works, it can save you a lot of money in transaction charges.
Andrew Collins has 10 years experience as a fund manager and runs his own consultancy, CM Financial. He also contributes to the CFD Industry website, www.CFDs.com
The first major benefit of using Level 2 is that it is the main mechanism used by the market to trade. It is used by all of the major traders such as institutional investors, hedge fund s, and private individuals. Its benefits are significant as it enables market participants to buy at the bid and sell at the offer price. Consider the following example which is a screen print taken of the Level 2 screen for Carnival Corporation towards the end of last year.
(see attachment)
Before I go into more in-depth analysis I will briefly explain what the information displayed on the screen means:
* On the left hand side are shown the willing buyers of the stock, the number of shares they want and the price they are willing to pay (which is known as the bid price).
* The right hand side shows the number of willing sellers, how many shares they have to sell and the prices they want for their stock (the offer price).
* The yellow strip shows the keenest prices that are close to being filled. In this instance we have one person or institution that wants to buy 500 shares at £29.88 and three willing sellers with a total of 1,857 shares that they want to sell at £29.90.
Normally Carnival can trade with quite a wide spread, but on this occasion you can see that it is only two pence. So what does this mean if you want to buy the stock? With Direct market access you have two options and we will assume that you only want to buy one thousand shares. With the quote standing as it is, there are three different sellers who are willing to sell a total of 1,857 shares at a price of £29.90. If you were willing to pay this price and are fast enough in using the system it would be possible to buy your 1,000 shares now at £29.90.
Another option is that you want to pay £29.89, and by completing an order on the system your entry would change the quote on the yellow strip to £29.89 - £29.90, showing your willingness to buy at this level and all you now need to do is wait until someone comes along that is willing to sell at this level. Of course this is not your only option, you could input any lower price that you would like to buy at, but it will mean that your order will not be filled until those above who are willing to pay a higher price have their orders completed.
We have considered buying some stock, but what about selling? As you would guess, the exact opposite happens. The orders on the right hand side show the number of willing sellers and the prices and volume they want to sell at. Now if you were selling 1,000 shares there are again several options available to you. If you wanted to receive a price of £29.88, there is one individual who is a willing buyer of 500 shares at this level. If you input an order to sell 1,000 shares at £29.88, this would mean you are left with a balance of 500 shares to sell and the quote on the yellow strip would change to £29.87 - £29.88 showing the 500 shares you have left to sell at £29.88 and you would have to wait until a willing buyer came along who wanted 500 shares at this price. It could be that other sellers could come along wanting a lower price than you and this could push the price down further leaving you with 500 shares unsold.
A second option would be to sell the 1,000 shares at the best price possible. The Level 2 system would then take the 500 shares on offer at £29.88 and sell the remaining balance at £29.87.You will see from the system that after the £29.88 level, there are 5 willing buyers of 2883 shares at £29.87, so there is more than sufficient demand to take your remaining 500 shares at £29.87. This would therefore give you an average price of £29.875 for the whole 1,000 shares. It could be that you want to sell at a much higher level of say £28.93 and in which case your order would sit on the right hand side of the book waiting to be filled. Until a willing buyer comes along your order will remain on the Level 2 system.
You can see from the quote for Carnival the depth of the order book which at this moment in time was not very deep. There were not that many buyers around so it would not have taken much selling volume to push the price down. This is something that you will learn to spot with experience and different stock prices will behave in different ways. Early in the morning when the order book is still getting up and running, volume can be quite thin and there is sometimes an opportunity for bargain hunting. A stock such as Carnival is very interesting to watch and can be very volatile because it is a high priced stock that can move on low volume. You can see just from this example how hedge funds could potentially move a stock price very quickly. The number of buyers at this moment was quite small and it would not have taken much short selling to push the price down especially if any negative news were to be announced.
Be Careful!
When using the order book be very careful when typing in your order. The order book is the market and any error inputting your requirements can be quite costly and very difficult to amend. For example, the simple error of typing in a price that you are willing to pay which is much higher than the current price may result in you paying a much higher average price than you should have done and this would be almost impossible to undo. Also be very careful with typing in the quantity, this is another area for making a silly mistake which will be very difficult to unwind.
Partial Fills
This is an important factor to consider. If, for example, you placed an order to sell your 1,000 Carnival at £29.90, but only 500 were sold before the price fell, you will have paid commission on a partial sale at that level, but if you were to amend the price to a lower level at which you were willing to sell the remaining holding, this will be considered to be a new order and you will pay a second lot of commission. If you are dealing in a sizeable amount, the impact of this will not be so great, but it will add up for smaller trades. The answer is to watch the market very carefully to ensure that you get the price you want for all of your stock.
Quote Driven Alternative
The alternative to using Level 2 is a quote driven system. This is basically as it says a pure quote without any details about market depth as you get with Level 2. All brokerages will operate some form of quote driven system based on the underlying market quote derived from what is happening on the Level 2 system. What you have to be very careful of is that because you are deemed to be an intermediate customer, the brokerage is not obligated to give best execution which basically means that the quote they offer to you may differ fractionally from the underlying market. This means that, for example, British Airways could be quoted at £2.05 to £2.06 in the market, but a quote driven system may offer you £2.0475 to £2.0625, the broker then keeps the difference.
This is why some brokers will offer a deal for free service. The reason it is free is that the broker has increased the spread around the underlying market price which enables them to make a profit on your transaction without having to charge commission. It always pays to find out exactly how your broker works, it can save you a lot of money in transaction charges.
Andrew Collins has 10 years experience as a fund manager and runs his own consultancy, CM Financial. He also contributes to the CFD Industry website, www.CFDs.com
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