DMA Spread Betting

You hear a lot nowadays about the advantages of DMA (direct market access) trading. Direct market access allows you to see what the market is doing directly. DMA CFD trading has been the preference of professional share traders for many years now 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. The level II display shows you the orders that are pending in real time on the trading market, and that means that in addition to seeing prices you can also see the depth of the market, which means how many trades are pending at any particular price level. But what is DMA Spread Betting?

“The key benefit of DMA spread betting is that it allows a trader to act also as a market maker through posting their own bids and offers, queuing at different prices where ‘gaps’ appear, or at defined support/resistance levels. For some spread betters, perhaps the other advantage is that the investor can be sure that the prices quoted are real time and accurate and that they will only ever be filled at a true market price and not some spurious spread bet firms own price, a major bug bear for many traders, particularly in volatile markets where stops get triggered even through the underlying prices may not have reached that level.”

DMA (Direct Market Access to the market) means that an actual transaction is executed in the respective underlying market. The main benefit of this is of course greater transparency: there is no possible conflict of interest between the trader and the broker; the broker gets a commission every time you trade so the focus is on giving clients every opportunity to make money in the market.

  1. Inclusive Level 2 prices – A good DMA spread bet provider will supply you full access to what is called the ladder – this is the depth of the market instrument that you are interested in and it allows you to see each individual bid price and offer price. It is also called Level 2 access and many stock market data providers charge separately up to GBP50 per month of this. With Level 2 you can see the true depth of the market and check where there is true support for a stock price (or resistance) and also if the share price is being propped up on thin volume for instance.
  2. Ability to trade in Auction Periods – Many traders are aware that there is an opening and closing ‘auction’ in stock price during which all the bids and offers placed by participants are collated by the LSE and an opening and closing price that fills the optimum amount to satisfy the supply and demand is struck but hitherto which they have been unable to participate in.  With DMA trading you can actually participate in this auction process whereas with standard spread betting you cannot.  Sometimes, when a stock moves a predetermined amount too (generally 10%), many of you will have noticed that you cannot trade in the stock while it’s in an interim auction – a period of around 5 minutes when the LSE carries out the same process as with the opening and closing auctions.  How many times have you seen this and then the shares open out of the auction and move dramatically?  With standard spread betting you cannot trade usually during the auction period but, with DMA trading, then you can actually participate in that auction and so trade at the uncrossing price.  This is particularly useful when an RNS comes out and the stock moves immediately into auction – savings can be considerable if you are able to trade in these as opposed to waiting for the auction to end.

Non DMA spread bet firms quote their own prices and, in what is a little known fact, they actually have no obligation to follow the quoted prices offered by the exchanges. At certain providers that claim to offer DMA, a small spread is added to the underlying market price that you trade at – effectively the same as a commission.

DMA/ECN/STP are interchangeble. DMA means ‘direct market access’ and ECN means “Electronic Communication Network”, STP means “Straight through processing”. To clarify DMA (Direct Market Access) would be utilised for exchange traded products (equities and derivatives).

Just to clarify DMA would be used for exchange traded products (stocks and derivatives) ECN and STP can perhaps be viewed as more spot FX orientated (though not exclusively). ECNs were originally established to facilitate trading outside of stock exchanges.

Spread betting companies work on a principal to principal basis. Thus, if you are trading forex that means that the price you are being quoted will depend on the companies own book as well as the liquidity providers that they use. Because spot FX is not conducted on an exchange it therfore stands to reason that competing ‘brokers’ will have different prices.

Let’s now consider shares trading. You may be wondering at this stage how this is implemented with DMA or real time spread betting. You can see the spread in the market on the level II screen, and the bid and offer prices on display represent the potential buying and selling of actual shares or other financial products. The display shows prices either side of the current market values, which will represent trades if the price moves a little. As you know, spread betting is based on the prices, but does not involve the actual transaction of shares.

The answer is that unless you are actually share dealing the level II screen is only indicative, and doesn’t represent spread betting prices. The quotes that you receive from your spread betting provider are the values that you can place a bet on, and not the numbers that are provided on a level II DMA display. Spread betting providers are market makers, which means that they choose their own prices for each security that they allow you to bet on.

Interestingly, this can mean that you get better spreads than are displayed on the direct market access screen, as the spreads are usually fixed for any particular provider. The spread betting provider will certainly try to keep the quoted prices around the direct market price, as by doing so it minimizes opportunities for the trader to profit from arbitrage, buying at one broker and selling at another and waiting for the prices to come back in line to take a profit.

From what I understand a spread betting firm which offers DMA is not a market maker; they are just offering the means to be able to make bets based on the underlying liquidity providers’ prices (with, some fixed spreads added on top to cover costs). Thus the only way a true DMA spread betting firm makes money is through the spread.

Spreadbetting involves trading a derivative of the underlying. Now, it has been said that because spread betting takes place with market makers, the trader is always betting against the broker and investors sometimes fear that because of this the may stand to profit from clients’ losses. To some extent this is true, as the broker has to take the other side when you place a bet. However, if priced right the broker expects that other clients will take an opposing position, and this will balance out his potential liability to you. Having said that providers make money from the spread bet so their interest is in clients continuing to deal for as long as possible. Another problem is that as a client; your counter party is not the Exchange; even with DMA; but rather the broker.

The other advantage of spread betting providers, or bookmakers, being market makers is that you can spread bet on a wide variety of financial instruments, including some that would not be available to you with direct market access. If there’s a market for the better then a spread betting broker will seek to provide that facility. Many of the items that you can spread bet on, if traded in the general market place, require a minimum lot size. Examples of this include the Forex market and commodities. With spread betting, you can decide on the size of your position, and do not have to relate it to that demanded by the general market.

It is also interesting to note that there is one spread betting broker (ProSpreads) out there that claims to offer zero tax day trading with DMA Functionality i.e. offers DMA with a spread bet wrapper, otherwise (so they claim) they are simply acting in the same way as any futures broker. In return for the spreadbet wrapper you pay higher commissions but I think many bigger futures traders are likely to be better off paying higher commissions and no tax. However, ProSpreads isn’t really DMA because I don’t think it would qualify as spread betting if you were accessing the markets directly. However, this company’s offering is more akin to futures trading than spread betting per se’ and is definitely not for beginners.

I do spread bet as well as use CFDs and shares. My problem with spread betters is that they are more like bookmakers, I prefer to be able to place my orders direct onto the order book. As I said the only spreadbet company I know that is close to this is ProSpreads.   If you would like to trade CFDs directly with direct market access I would suggest you to use IG Markets

So why cannot you DMA spread bet?

The main reason you have to deal with a spread betting broker and you cannot DMA spread bet is that because if you want the tax advantages of spread betting you have to bet with a bookmaker. In effect spread betting firms are market makers but it is the same as a bookmaker at a horse track: you transact with the spread betting firm. The spread betting company has to quote a price if they want your business.

All spread bet providers work on a principal to principal basis. If you are trading foreign exchange for instance that means that the price you are being quoted will depend on the provider’s own book as well as the liquidity providers that they use. Because spot FX is not conducted on an exchange it therfore stands to reason that competing ‘brokers’ will have different prices.

The way it works is that spread betting providers quote you a price with all the costs – while trading on an exchange (DMA trading) comes with extra costs like stamp duty, clearing fees, brokerage…etc Since spread betting providers have to quote your a price with all the costs built into the spread and deliver to you a price to bet on, they have to build their own betting platforms for clients to place their bets. Also, because spread bet clients do not always transact in marketable amounts they have to deliver a price on a platform to you as opposed to a platform that will execute on an exchange i.e. spread betting providers also have liquidity providers but they have to deal with all levels of bets some fractions of a contract size some normal contract size and marketable amounts.

That in a nutshell is why spread betting companies have to build their own platform and why they cannot use trading systems like ninjatrader

If one looks at spread betting over the last ten years spreads have been getting better and better and I believe the industry will get even more competitive but this has to come through technology and efficiency otherwise spread betting firms will not be able to keep reducing spreads as the profits will be taken out.