Trading CFDs with Direct Market Access

Understanding DMA's impact on the CFD industry, by Atif Latif, Guardian Stockbrokers

Trading DMA (Direct Market Access) CFDs has become the investors’ tool of choice when trading the markets short term. Historically DMA has been the preference of professional traders as it allows for trading the markets with complete transparency and full control of entry and exit levels, due to trading directly onto the stock exchange order book.

DMA trading allows investors to view and trade directly onto the Level 2 order book, across exchanges such as; LSE, Chi-X, BATS & Turquoise. Trades are executed by hitting the bid/lifting the offer, and by queuing at different prices where perhaps gaps appear, or at defined support/resistance levels.

The advantage with DMA trading is that the investor can be sure that the prices quoted are real time and accurate and that it can therefore avoid spreads widening in fast markets, which on occasions can create spikes that trigger stops when the underlying price may not have reached that level.

Some CFD providers quote their own prices for various investments, they have no obligation to follow the quoted prices offered by the exchanges which therefore creates uncertainty in price movements. This uncertainty is eliminated by DMA CFD trading as this role is taken by you being a price maker. DMA CFD providers do not look to profit from your losses so there is no conflict of interest, and more importantly they not trading directly against you.

Level 2 data is the amalgamation of all orders on both the buy and sell side. Shown in price order, this enables institutions/investors to see where to place orders into the market directly, and retail investors are now able to view the same data. This results in total transparency as investors are able to see small price movements in real time, allowing them to identify technical support and resistance levels.

Retail investors effectively become a price maker in the market as they are able to decide where to place buy and sell orders, whereas historically they have been a price taker. More importantly all price quotes and liquidity are directly identical to the underlying market.

This provides transparency which is of paramount importance to investors trading short term, as a better entry/exit level can add value to the profitability of trades. Investors are able to see the order book for companies listed on the FTSE all the way down to AIM companies, allowing them the added benefit of seeing where the volume is being traded at specific prices in the market.

The advantages of DMA trading are a combination of being able to achieve best prices for investors, no additional spread on prices, and the ability to be in full control of where to buy and sell. It is also useful to note than investors can trade the aforementioned real market price, which gives better and faster execution and more importantly allows investors to work multiple orders such as GTC, GFD, Fill or Kill, Execute and Eliminate, Iceberg, At the Open, At the Close & Intraday Auction.

For large sized transactions Iceberg orders are a useful addition to this list as they allow the investor to place large orders into the market by only showing a small part of their intended overall size, and this is particularly helpful when trading stocks with a lower level of liquidity. Similarly, in the opening and closing auctions larger sized trades have a greater chance of being filled than during normal trading times.

Once an order is placed investors are able to see their position working in the market. In addition to this, some platforms offer the function to trade across a number of exchanges as mentioned above, this offers a larger liquidity pool and also give opportunities to arbitrage across exchanges. In simple terms this means that an investor may spot that one exchange is offering a different/better price than another, allowing them to buy at the better price on one exchange and sell at a higher price on the other.

Given all the positives for DMA trading outlined above, as with any product, there are some disadvantages worthy of note. If the investor is placing their own trades onto their trading platform the risk of creating the wrong order type or direction can be high, particularly if experience levels are low.

Fat finger trades can also be a risk where orders are placed for the wrong size, exposing the investor to a larger trade than they had intended. There are still a large number of investors that prefer to call their broker to place orders for them, this allows the investor the peace of mind that the broker is then responsible for executing the trade and the ability to gauge market colour and information that may not be readily available. This method tends, however, to dramatically increase the costs of trading.

As with any stock market investment there is a risk, and the risk is amplified when trading products like CFDs because of the leverage aspect of the trade. This allows the investor to use a small deposit to buy a position of a much greater value, but still leaves the investor exposed to the entire value of the trade in a long position and potentially unlimited in a short.

Also some investors may overtrade, due to the ease of using a trading platform, this may result in losses and or unnecessary over exposure. It is therefore important that all investors looking to trade CFDs have a good understanding of the mechanics of trading on leverage and have robust risk management strategies in place to minimise the risks involved.

Normally this will be by way of education about CFDs and developing a trading strategy, to suit your risk profile, this can be aided by the use of demo accounts and or if you are seeking advice, by using a broker with the relevant experience and qualifications.