All
Does anyone have an idea about how important it is (or is not) to use a direct-access broker to place trades? I hear it is possible to eliminate a market maker in many cases and therefore save some money on those trades? I was looking at Terra Nova Online (which is a direct-access broker) but had some concerns about their web site.
Thanks for any comments.
MJ
Many Direct access brokers charge high commissions and are interested mainly in daytraders who do a hundred roundturns a day ( done it myself in the past for quite a while ).
Having direct access to an ECN doesn’t mean, that it’s cheap. Almost all ECN’s charge a certain amount/stock to your broker and he charges it to you.
Direct access is necessary when daytrading, because you need lightning fast executions - remember, daytraders scalp for a few cents movements with huge lotsizes. You can never achieve this speed with a browser based webbroker.
Hence, what you might save on order tickets with some DAB’s, you pay for their tradingsoftware ( which gives access to the ECN’s ) and realtime data - both you need to have access to your account and being able to trade.
Usually, they charge in the range of 100 - 200 US monthly for renting the tradingsoftware. Of course, if you do a million $ turnover a month, you’ll get it for free plus special commissions and fees 
Also many DABs don’t allow open overnight positions, have no GTC orders and require a minimum of 25K of cash or equivalent in your account at any time in order to fulfill the SEC daytrading rules - but can get up to 4 times margin for intraday trades.
So , DAB’s are mainly interested in two things :
Usually, in daytrading you turn lotsizes of 500 or 1000 shares
.You can see that yourself when looking at Nasdaq L2 quotes - most of the prints in smaller priced stocks are 1000 shares. Higher priced issues might trade in roundlots of 100 and multiples.
For the kind of investment you want to execute with 123P strategies, any good and reliable onlinebroker will do.
Actually, if they would also offer margin accounts , FolioFN could be a very good choice for this kind of investment strategy.
But no special recommendations of retail onlinebrokers here from my side. Ameritrade, E-Trade, etc. you name them.
Personally, I’m working with Interactivebrokers ( Timber Hill Group, Chicago ) since many years and I’m happy with them - low fees, still direct access to any ECN, options, futures currencies and about 40 world markets to trade. Plus sophisticated orders and to some extend, smart order-routing as well. Not much to complain about.
Nowadays, I do only about 300 roundturns a year -much less then in earlier years, holding anything between 10 and 20 positions at most times and IB saves me a lot of money due to their low fees. 
regards
Something I always wondered about - when you eliminate the market makers with direct access, do you need to worry about bad fills?
I am worried about the case where I put in a market order before market opens and the stock doesn’t have good bid / ask prices listed. With my current broker I always get good fills but commissions are high. I would like to change to a different broker to lower my expenses but have this concern about fills.
Maybe there’s a misperception about the task / role of market makers. With DABs, you eliminate so called introducing brokers, but certainly not the market-makers. Without MM’s there would be not much trading going on on the exchanges.
Introducing brokers are those who have direct access to the exchanges and take over orderflow from those brokers and institutions ( i.e. mutual and hedge funds ) who don’t have this access. A number of online-brokers don’t have any direct access and so they route all customer orders through the introducing broker ( IB is such an introducing broker ) which can be a merketmaker also !
Furthermore :
“It should also be noted that market makers are required by law to give customers the best bid or ask price for each market order transaction. This ensures a fair and reasonable two-sided market.” ( Remark : no such obligation exists in pre- and aftermarket hours or for limit orders !!! )
Check also :
http://www.investopedia.com/university/electronictrading/trading3.asp
and
http://stocks.about.com/od/tradingbasics/a/Marketmak011205.htm
DAT( direct access trading ) is a system that allows a client to trade directly with another client, a market maker on Nasdaq, or a specialist on the floor of an exchange without broker interference.
ECN’s like Island, Archipelago etc. provide only the plattform were buyers and sellers can meet (electronically ).
(ECN= Electronic Commerce Networks )
It’s still the market makers who provide liquidity in a trading issue, not the ECN or the exchange.
The only difference compared to, say floor traders on the NYSE is, that on ECN’s and Nasdaq, there are no specialists for a certain stock.
Market-Makers ( large trading houses and brokerages ) decide, for which stock they provide a liquid market. But in any case, a private traders order goes into the orderbook via a market-maker - the one who provides access to the market for your broker.
Market makers live mainly from the spread - not from comissions. Actually, some market-makers even pay Brokers in order to get all their orderflow.
I.e. say your broker is Etrade, then Etrade routes your order through it’s preferred channel ( Market-Maker ). The marketmaker might offer a little higher spread or ist faster in excution and makes a cent here and there - given the volume market-makers move on each trading day, these little spreads add up significantly and provide the major revenue source for them. That’s the benefit. On the other hand, without a marketmaker, a stock would have much higher volatilty and probaly much higher spreads, because if there are only few buyers and sellers with bids far away from each other, the trade would never been matched.
The marketmaker has always to provide a market on both sides of the trade, so you can be sure, that your stock can be sold - however, he’s not obliged to stick with a certain spread. It’s up to him ( and the competition ) to define his prices. If he’s too far away from a market, he doesn’t make any trades and hence no business.
So the strategy of Marketmakers is always to buy on the way down and sell on the way up… and be flat at the end of the day - but that’s up them.
A direct accessbroker is linked directly with the ECN and your order is displayed at the ECN you selected as a trader in your workstation.
For most private traders ( not daytrader though ) , it is unappropriate to go this route, since they would have to follow prices on all other ECN’s in order to make sure, the to get the best prices offered on all markets.
Hence many DAB brokers offer so called “smart routing” fucntionality , which selects already the best price for yoour order on all ECN’s and the best price should fill your order. Most of the time , this works very well.
The good thing for a trader is, that in popular stocks, many marketmakers ( maybe 30 or 40 ) meet on the ECNs and compete in the same stock. Hence spreads are low in order to avoid arbitrage trades by other Pro’s.
In less liquid stocks, the situation is somewhat different, but actually, as a retail investor, there’s not much you could do about it - with or without direct access.
In a nutshell :
eliminating market-makers by using direct access is not really possible - someone has to provide the liquidity in a stock.
So you may buy from one MM and sell to another.
Unless you trade huge blocks of 5K or 10K shares several times a day in less liquid stocks, you don’t have to worry about the quality of your executions.
Markets are very competitive today and no intraday gap lasts very long.
A different story is Instinet - were only institutions trade large blocks.
For more info about how ECN’s work :
Privateer,
I appreciate your thoughtful and informative reply. It’s very helpful.
Thank You,
Mark
Privateer makes a good point. DABs want day traders who give them a large volume of shares, and, in turn, day traders who want and need DABs for lightening fast fills.
As to using P123 ports, I don’t get the idea of saving money on commissions, when the average discount broker charges only $10 +/-$3 per trade. Assuming you’ve got $30,000 in work capital, and the average P123 port consists of 4 stocks, turns around 4.5 x per year, the commissions are only ($10 * 4 * 2 * 4.5) / $30,000 = 1.2% per year which is very modest, negligible, and manageable, especially if you’re expecting to make anywhere between 50 and 100% per year.
As to bad fills in unlisted stocks - because just about all P123’s stocks are NASDAQ stocks, NOT listed stocks - DABs have no special privileges that discount brokers supposedly don’t have. You maybe able to trade directly from the offices of DABs, but…
Unless you trade on an ECN, no, you cannot eliminate MMs. DABs don’t have any special privileges because both they and other brokers (including discount brokers) send their orders to one or more NASDAQ MMs who, by definition, are the NASDAQ market. MMs provide the liquidity and small/competitive bid-ask spreads we all need and want.
I hope this helps.
Exactly Robert.
The real “edge” for a daytrader comes from seeing and analyzing the orderbook ( Level II quotes) and beeing able to route the order to the ECN which provides the best price.
After having done that for quite a while several years back, I can say, daytrading it can be very rewarding at times , but also frustrating at others - in any case it’s very very stressfull - no matter how good your DAT software and your TA skills are.
If you like, take a look at Tony Oz’s Book : The Stock Trader.
It describes, how Tony ( a professional trader ) made money in a four weeks time frame , when the markets had their biggest crash in April 2000 by only going long stocks - in daytrading, or better, intraday swing trading.
It’s kind of scrap-book where Tony describes everything he did - from opening a new account with a DAB to stock selection and trade execution and managing his trades.
He made 28K on a 50K account in 4 weeks by going long only while the markets tanked sa much as they haven’t done since decades - no futures, no hedges, no options. Just plain intraday trading.
I had a number of conversations with Tony back then over at the Elitetrader boards and was always fascinated, how he was able to sustain the mental wearout of this treadmill day after day.
At one point,even though having had success and making money, I had to admit, this kind of trading is not for me.
Again, for 123P investing, this all is not really necessary.
Even though I have the possibilities to do this today with IB, in 99% of all my trades I use Smart routing for my orders.
I believe, for our kind of trading / investing, its more of importance to have the ability to use ordertypes which fit to our trading style.
By this I mean trailing stop losses, OCA orders, conditional orders , sometimes Iceberg and so on including GTC duration ( often not possible with DAT Brokers ).
regards
Stefan
p123robert,
I’m not so concerned about commissions as I am about some broker selling my order to the highest bidder (MM) at my expense. This was the reason for my original post. I really don’t know how much this happens and if it can be prevented to some extent by using DABs that allow you to choose the ECN you want to use and not letting them do it.
It’s possible that it’s not a big problem or that there is nothing to do about it, in which case I’m paranoid and I should quit worrying about it.
Regards,
MJ
Hi Markajohn,
No, I don’t think you’re paranoid. Your worry/concern is fully justified. You’re not alone, as most of us retail (and institutional) customers worry about this very same possibility. We keep praying that our brokers will not overcharge us in the form of higher than market fills. In my experience, overcharging can be prevented by not going through a (discount) broker who - as a compensation for his lack of income and his deep-deep discounts - is making money at our expense, by sending our orders to the worst MMs who pay the most money for order flow.
You do have some control. You can specify if your order is a “day” order, or “extended hour” order. Or Market, Limit, Stop-Market, Stop-Limit, etc. order. Additionally, many, but not all, retail brokers offer you 2-6 additional ways to route your order. This includes a few ECNs, MMs, and, of course, Auto Routing. Market orders sent by Auto Routing tend to get the fastest and fairest fills at the best possible prices. Of course, there are no guarantees… your experience will vary. Some of your orders will be filled above the market. Other orders will be filled below the market. On the long run, all of those differences should even out. On the long run, you should get a 0.0% or better slippage.
How do you find out? Well, examine the trading history of your own account! This is especially easy, if you send in all of your orders as “auto-routed” “market” orders for the “day”, and if you send in your orders well before the markets open at 9:30 a.m. Eastern. Examine your account history. If you’ve got a broker who consistently overcharges you in the form of higher than published open prices (on bigcharts, yahoo, msn.com, etc.) then why keep her? Why give your business to a broker who, as a compensation for her lack of income and deep-deep discounts, makes additional money at your expense, by sending your orders to the worst MMs who’re known to give poor fills and pay the most money for order flow? If you consistently get poor fills, then I know my answer is clear… you want to find a better broker!
OTOH, if, on the long run, the differences in between your fills seem to even out, and if you get a 0.0% or better slippage, then try to not to worry about this issue. Try to be happy and make an attempt to lay your concerns to rest.
I hope this helps.
Robert
Robert,
Thanks for the helpful post.
Your comments about discount brokers agree with one of the salesmen at Terra Nova.
Can you recommend any brokers?
Regards,
Mark
Hi Mark,
You’re welcome. As to your question, I answered a similar question in a different thread at http://portfolio123.com/mvnforum/viewthread?thread=1144&offset=20
Robert