What it means
In ordinary trading, a client tells a broker what to buy and the broker decides where and how to execute it. In direct access trading the client's software sends the order itself, tagged with the venue it should go to, and the broker simply passes it through its connection to the market.
The broker's role shrinks to providing access, credit and risk controls. This matters because routing choices affect the price a trader actually gets.
Different venues show different prices and different amounts available at each price, and a good router can pick the venue with the best price or a better rebate. For a firm trading thousands of times a day, those small differences drive the whole profit and loss.
Direct access also gives traders order types that are not always on offer in simple retail platforms. Examples include hidden orders (which are not shown in the public order book) and orders that only post and never take liquidity.
These tools let a large buyer or seller avoid revealing intentions to the market. From a finance perspective, the key concern is cost and risk.
Costs come as per-share fees, venue charges and technology spending, while risks include operational errors, platform outages and the loss of money from fast, automated mistakes. Many firms set hard limits on position size and daily loss so that one faulty order cannot do lasting damage.
A common nuance is the difference between access and execution quality. Direct access gives the means to get a good price, but the result still depends on the skill of the trader or algorithm using it.
Measuring that skill is usually done by comparing the price achieved with a benchmark such as the price at the moment the order was placed.
In practice
Real-world examples.
Example
A hedge fund's trader needs to sell 100,000 shares of a technology company in one afternoon. She uses a direct access platform to release 2,000 shares at a time across several venues, keeping the price from dropping sharply. The average sale price ends within a few cents of the morning quote.
Example
A commodities trading company in Singapore hedges its fuel purchases through futures contracts. Its risk team uses direct access to send orders straight to the exchange during busy periods. This avoids delays that used to cost it money when prices were moving fast.
Example
A founder who received a large block of shares from a company sale wants to sell gradually. She hires an adviser who uses direct access trading to sell small amounts over several weeks. The approach keeps her actions from signalling a big sale to the market.
Formula
Calculation
Slippage cost = (average fill price - price when the order was placed) x number of shares, for a buy order
A trader decides to buy 5,000 shares when the quoted price is $20.00. Using direct access, the order is split across venues and fills at an average price of $20.03. Slippage = ($20.03 - $20.00) x 5,000 = $0.03 x 5,000 = $150. If the same order sent through a simple retail route had filled at an average of $20.07, slippage would have been $0.07 x 5,000 = $350, so better routing saved $200.Case study
Seen in the real world.
Brightwater Securities is an illustrative, fictional trading firm that executes about 300 trades a day for a small group of wealthy clients. Its original setup sent every order through a single partner broker, and clients occasionally complained that quoted prices had moved by the time of execution.
The head of operations tested direct access routing for one month and tracked slippage on every order. Average slippage fell from $0.012 to $0.007 per share across 4,000,000 shares traded in the month, a saving of $0.005 x 4,000,000 = $20,000.
Monthly technology and data costs for the new setup were $14,000, so the net gain was $6,000, which the team judged too thin to justify the extra operational risk. The illustrative lesson is that direct access pays off only above a certain trading volume.
Watch out
Common mistakes.
- Believing direct access guarantees a better price, when the result depends on the quality of the routing decisions made by the trader or software.
- Ignoring the fixed costs of platform, data and compliance, which can exceed the savings for firms that trade infrequently.
- Forgetting risk controls, when a single mistyped order sent directly to a venue can cost more than a year of savings.
Questions
People also ask.
What is the difference between direct access trading and algorithmic trading?
Direct access describes how an order reaches the market, while algorithmic trading describes how the decision to trade is made, and the two are often combined.
Do I need a special account to use direct access?
Usually yes. Brokers that offer it often require a minimum balance and a signed acknowledgement that the client understands the risks of direct order entry.
How is execution quality measured?
By comparing the average price achieved with a benchmark, such as the price when the order was placed, and then adding the fees paid.
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