Why Swing And Intermediate-Term Traders Should Consider Using Direct-Access Brokers

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 |
Quote |
Chart |
News |
PowerRating),
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.

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