Many are unaware that there are two different types of Contract for difference brokerages. Firstly, there are those who simply take the role of agents executing all orders on the underlying exchange, this type of brokerage gives it’s customers direct market access. In contrast with Direct Market Access brokerages their are Market Makers who make a market and then live off the spread. With Market Makers taking a number of different measures to manage their risk. To learn how Market Makers manage their risk check this post out.
When trading with a brokerage that offers Direct Market Access, the bids and offers on display will match those in the underlying market. This means that the spreads on offer are much tighter than brokerages that operate on the Market Maker model. Though when trading with a CFD brokerage that offers direct market access you will have to pay fixed commissions on each position opened. This can really eat into smaller traders profits.
With a Market Maker, they will determine the spread on the given instrument to manage risk and to increase profits the Market Maker will often offer spreads considerably wider than those found in the underlying market. When hitting buy you may also experience slippage and re-quotes which is particularly annoying, however you are less likely to have to pay a commission on each position opened with the brokerage. Which can be beneficial to those who have limited funds to trade with.
Choosing whether to use a Market Maker or Direct Market Access brokerage really depends on your needs and what products you intend to trade. The shorter your trading time frame the more beneficial a Direct Market Access brokerage will be. However if you want access to a wider range of global markets a Market Maker may offer you a better range of instruments to trade. This is due to the fact that a Market Maker can theoretically create a market for any tradeable financial instrument, whereas a Direct Market Access brokerage would need access to the particular market. A lot of professional traders will use both for these very reasons.
Given the advantages of brokerage who offer Direct Market Access (DMA) why do people use Market Makers? Well Market Makers have a number of benefits for one they tend to offer a wider range of markets, including foreign and illiquid markets. They also tend to allow traders to access the markets with less capital and undertake smaller size trades. For example to trade CFD’s with DMA broker you may need to open account with at least $2500, but many Market Makers allow you to trade the markets with as little as $100 (theres even a few regulated brokerages that allow you to trade the markets with as little as $5).
Liquidity can also be an issue with Direct Market Access brokerages. For example suppose you want to buy 500 Shares of a particular company if there are only 10 Shares available to buy you won’t be able to execute your order. It is for this very reason that one can’t take advantage of guaranteed stop losses at a DMA brokerage, due to the fact that there is a chance that you won’t be able to close a position at that particular price.
Both Direct Market Access and Market Makers have their own advantages and deciding which to trade with will largely come down to what your particular needs are. In an ideal world it would beneficial to have access to both a DMA and Market Maker, but many will forced to pick one over the other and they should consider which brokerage model would suit them better.
