Why Swing And Intermediate-Term Traders Should Consider
Using Direct-Access Brokers
By Loren Fleckenstein
Day traders pioneered electronic direct-access systems to scalp professional
market makers. The advantages were unmistakable. Direct access enabled
immediate execution and confirmation.
And just as important, direct access allowed traders with large orders to route
their trades to market participants dealing in the largest possible inventory,
raising the odds of getting a complete fill at your price.
Direct-access technology has even automated a solution to the problem posed
by ECNs fragmenting the market in after-hours trade. Direct-access software can
scan all Electronic Communications Networks and zip the day trader's order to
the ECN with the best price at that point in time.
Yes, direct-access trading is just the ticket for day traders.
Wait a sec! Why should only day traders benefit from direct-access technology?
Anyone who trades stocks off price and/or volume signals needs rapid order
execution. This applies whether you day trade, swing trade or take positions for
the intermediate term.
To be sure, a number of online brokers have trotted out rapid order execution
alternatives for active traders. Direct-access brokers fetch higher commissions.
Depending on your trading style, account activity and order size, higher
commission costs may offset any gains you obtain by reducing slippage.
However, be aware that those low commissions still come at a price. Your online
broker typically routes your order to third party trading firms like Knight Trimark
for your fill. That's a slower process than smart order-routing technology, which
shoots your order directly to the market participant bidding or offering at your
chosen price.
Order confirmations often will be slower. Direct-access confirmations typically
show up on your screen immediately upon execution. A mainstream online
broker typically relies on an email system. Your order is passed on to a trading
desk for handling, with email confirmation in some cases taking a minute or
longer to post your return address.
One thing is certain. Brokerages are catching on to the fact that they must
provide direct access as an option to their customers or lose their most active,
and thus lucrative, accounts. NexTrade Holdings, a leading developer of direct-
access software, says its has developed direct-access products for 70 broker-
dealer subscribers.
 Our programming staff has gone from five people to nearly 30," NexTrade
President John Schaible told TradingMarkets.com. "Our list of projects to
program, if we did not add another today, would be completed sometime in mid
2001. We have been working on a complete system redesign for almost 10
months to handle the increased volume in service requests. We re being killed by
too much business."
To get an idea of how direct access works, we'll take a look at a simulation of
direct-access broker CyBerCorp.'s CyBerTrader platform. CyBerCorp originated
as a developer of trading software and launched its direct-access brokerage,
CyBerBroker, in December 1997. The company was recently acquired by
discount broker Charles Schwab. Other direct-access brokers and/or software
providers include All-Tech Direct (www.attain.com), TradeCast Securities
(www.tradecast.com) and TradeScape (www.tradescape.com). The CyBerTrader
software and account features come in several variants, ranging from full-blown
Nasdaq Level II to scaled down Nasdaq Level I versions.
As with a regular online broker, you can access your direct-access account via
the Internet, although your must use a broadband connection such as digital
subscriber line (DSL) or digital cable. A dial-up connection can't hack the heavy
data traffic of this system.
Now, let's take a look at the CyBerTrader demo screen. To save yourself the
hassle of scrolling back and forth between my explanation and the demo, you
might want to print out this lesson and follow the text in the hard copy.
Be aware that the demo represents a simplified configuration of the software. If
you're interested in configuring the software's bells and whistles, you can
download a simulator from the company's Web site at www.cybercorp.com. For
those who seriously consider a direct-access broker, I suggest you familiarize
yourself with the simulator. If you think direct access is right for you, be sure to
comparison shop among as many direct-access brokers as possible.
For starters look at the Message display near the bottom of demo. Imagine that
you're the hypothetical trader in this demo. At 3:14:29 p.m. ET, you entered a buy
order for 500 shares of Oracle (ORCL), which was routed to The Island, an
Electronic Communications Network, and executed at 75 3/16. The fill was
confirmed at 3:14:30 p.m. -- one second later.
So now you're long 500 shares of Oracle at 75 3/16. Then the trade moves
against you. Glancing at the Account Manager (bottom of the demo), you can
see your Oracle position is minus 5/16 a share. You decide to unload
immediately your 500 shares.
At any point in time, of course, there are buyers bidding for a stock, and sellers
seeking to sell it. The highest price that the buyers are willing to pay is referred to
as the bid, the lowest price offered by the sellers is called the ask or the offer.
The combination of the two make up the national best bid and offer (NBBO), or
simply the inside quote or the inside market.
Near the top of the demo, you'll see the best bid, B 74 7/8, and the best ask, A
74 15/16, appearing in red type on the gray background. That's what Nasdaq
Level I shows you -- the inside quote. This is what you would see using a typical
online broker.
Now check out the Level II screen just below (in yellow). Level II shows all
market participants' bids and offers, not just the inside market. As you can see,
the CyBerTrader Level II display shows the buyers' bids on the left and the the
sellers' offers on the right.
As you can see, two market participants, a Deutsche Bank Securities (DBKS)
market maker and the Spear, Leeds & Kellogg/Redi (redi) ECN each are bidding
for 100 shares at the inside market. That totals 200 shares, 300 short of the
demand needed to fill your order.
To give yourself the best chance of selling all your 500 shares, you check the
next best bid, looking for a buyer with enough demand to absorb your supply. At
the moment, the next best bid stands at 74 13/16. You see bids for 1000 shares
each by a FleetBoston Robertson Stephens (RSSF) market maker, and Instinet
(INCA), an ECN owned by Reuters, and for 1,600 shares on The Island (isld), an
ECN owned by Datek Holdings.
You choose to route your order to The Island, the market participant bidding for
the largest number of shares largest inventory. In other words, you're willing to
sell at 1/16 of a point below the best bid to ensure you get out of your position,
rather than hoping more inventory will move up to the inside bid and running the
risk of the market moving further against you. So you are willing take the
additional loss of $31.25 (1/16 X 500 shares) as insurance of getting a good fill.
To do this, you just click your mouse on the area of the Level II screen displaying
The Island bid at 74 13/16 and pick your route by selecting The Island from the
drop-down menu in among execution options toward the top of the demo. Your
order pops up in the white order entry boxes: ORCL 500 74 13/16 ISLD. You
mentally verify that you correctly entered your order, then click the Sell button to
the right.
By choosing The Island in this case, you've actually done two things to improve
your odds of a good fill. The Island has the most liquidity. Second, because The
Island is an ECN, it will automatically fill your order if there is available inventory.
In contrast, market makers usually post only a limited portion of their inventory,
allowing them to change their price as orders are filled. Let's say you preference
an order to a market maker via Nasdaq's SelectNet order execution system. The
market maker is under no obligation to take the other side of your trade.
Meanwhile, you must wait at least 10 seconds before canceling your order.
The market maker is required to match your order if the order is sent via
Nasdaq's Small Order Execution System, and you can cancel SOES orders
immediately. But SOES orders are subject to tier limits putting upper limits on
the amount of shares you can buy or sell in a stock within a five-minute period.
So let's say you use SOES to buy 1,000 shares of a stock with a tier limit of
1,000 shares. You cannot buy additional shares for five minutes. (You can,
however, sell all or part of your position.)
There is still no guarantee that your order will be filled at 74 13/16. A large
enough order could hit The Island bid at 74 13/16 ahead of your order, removing
that liquidity from the market. In that event, your order will go completely or
partially unfilled, depending on how much inventory remained and whether you
instructed your order as all-or-none or allowed a partial fill.
With direct access and Level II screens, you also can try to sell at the ask or buy
at the bid. In effect, you are adding liquidity to the market. Of course, you now
depend on someone seeing your bid or offer and choosing to transact at that
price. If you bid or offer at the inside quote, your order will appear to anyone with
Level I or Level II looking at the same stock at that point in time. If you improve
upon the best bid or ask, your order will improve the inside quote and again
appearing on both Level I and II displays. If you bid lower than the inside bid, or
higher than the inside ask, you'll appear only on Level II displays.
Direct-access providers have automated many of these choices. CyBerCorp, for
example, has developed a proprietary routing capability called CyBerExchange.
This technology is particularly useful when you are removing liquidity from the
market. In other words, you are seeking to buy at the ask or sell at the bid, much
as you would using a conventional online account. In this case, direct access
vastly raises the odds of getting a prompt fill, especially when you're dealing in
large order sizes.
By choosing CyBerExchange routing, rather than selecting a specific ECN or
market maker, CyBerExchange scans all the market participants dealing in your
stock, then routes the order to the participants offering the best available price.
Let's say you enter a CyBerExchange order to buy 500 shares of stock XYZ.
CyBerExchange finds that 300 shares offered at the inside ask of 52 1/8, another
400 shares offered at 52 3/16. The technology will try to fill as much of your
shares as possible at the inside ask before moving on to the next highest price
level. In some cases, the technology will split up your order among multiple
market participants. However, your order will be treated as a single order,
incurring one base commission (not including ECN or exchange fees, where
applicable).
CyBerCorp's direct-access software also enables you to put in stop-loss
parameters, including trailing stop-loss orders or alerts, on the CyBerCorp
servers. As a result, your order remains invisible to the market unless triggered.
This eliminates the risk of market makers running the market down to pick off
your stops.
Copyright © 2001 by TradingMarkets.com, Inc.