Direct access routing offers traders direct access to the market where the actual trades take place.
Direct access routing is contrasted with using an online broker, where the broker acts as the middleman and places the order on behalf of the individual trader, usually bundled together with a number of different orders.
Not only does direct access routing allow the individual trader the ability to place orders directly on the market, but it also offers traders level II market access, which shows all the actual bid and ask orders currently on the market.
Direct Access Routing and Day Trading
Day traders in particular stand to benefit from using a direct access routing system to place their trades.
Not only does level II access provide day traders with the kind of real-time information that proves invaluable when trying to execute trades with a short open window, but the actual execution mechanics of direct access routing are significantly faster than the execution offered by online brokers, often executing seconds to minutes faster depending on the size of the order and the trade volume of the underlying security.
The disadvantage of direct access routing is that the trader will likely end up paying higher commissions on their trades when compared to an online broker. Therefore, direct access routing for individual traders is only worth it when their trading strategy demands the quickest access to the market.
Level II access to direct buy and sell orders on the market can be purchased from most online brokers, so traders can still access that information without using a direct access routing system.
Generally the day traders who find that they need direct access routing and can justify the increased cost are those who have been trading successfully for some time, and whose orders are large enough that their online brokers are failing to execute them quickly enough.
Many online brokers will make a market for small orders internally, which allows for quick execution, but they will do so less often with larger orders and for traders who are more successful.
Direct Access Routing and High-Frequency Trading
Much has been written about the influence of high-frequency traders and market-makers on the contemporary markets.
These are highly sophisticated automated or mostly-automated trading algorithms that use artificial intelligence and machine learning to profit from extremely short-term swings in the price of a security, usually taking a neutral position in the market and profiting from small changes in the bid/ask spread for a security.
As day traders use a direct access routing system, they will be competing with high-frequency traders who are placing direct orders on the market by the 100th or 1,000th of a second, which is far too fast for a human trader to track and react to.
This means that the orders for a security can shift extremely rapidly when an algorithm is highly active in a security, and the human trader will only see dramatic changes each second or so without seeing the high-frequency orders that are shaping the market.
Day traders using direct access routing should be aware of the existence of high-frequency traders, and be able to recognize when one or more is highly active in the security they are trading in.
These algorithms are highly unpredictable, and many are designed to run stop orders and drive prices up or down in a short period of time before capitalizing on the short term price change.
There are a variety of strategies for dealing with high-frequency traders when using direct access routing, and day traders are encouraged to prepare themselves extensively when trading on a direct access routing system.
While direct access routing is of little consequence to newer day traders, experienced and successful veterans may discover that they need to start using a direct access routing system for their trades to stay competitive and compensate for their larger order sizes.
The drawback to switching to a direct access routing system is that the trader will likely end up paying higher commissions on their trades when compared to a traditional online broker.
Another advantage of direct access routing is level II access to the direct buy and sell orders on the market, but most online brokers will provide this information for a separate fee.