Shares digital

The best way for traders to stay in control is to deal direct via the central order book of the exchange. Nick Sudbury goes to market

Level 2 data offers the big advantage of showing traders what is happening on the central order book of the stock exchange. This can help refine entry and exit levels, especially if the user signs up to direct market access so as to bypass the constraints imposed by market makers.

The Level 2 screen shows how the central limit order book changes in real time and users can see the full depth of the market. Outstanding buy orders are listed on the left and sell orders on the right. These are sorted by price/time priority irrespective of who placed them.

The top of the buy column is the highest price offered for the stock, while the top of the sell column is the lowest sale price. Together they make the current bid-offer spread. As orders are matched they are removed from the book with trades listed on the far right of the screen.

Paul Friel of Barclays Stockbrokers says Level 2 pricing ‘gives a better understanding of how a share price is derived and its possible future direction. One way to assess if this is up or down is by the ratio of buyers to sellers. Traders can also note large buy orders and set stop losses at the same levels, which gives some confidence of a buyer at that point.’

According to the LSE some 7,500 UK private investors subscribe to Level 2 data, but the number is increasing all the time. One way to join is to sign up to an online or software-based information provider. At MoneyAM.com, Shares’ sister website, this would cost £19.99 a month plus VAT or £219.89 a year. Alternatively, subscribers to ShareScope Gold and Plus can add a live Level 2 feed for an additional £16 a month.

Some stockbrokers also provide this data. Barclays includes it as part of its new BARX trading platform – £45 a month for those who deal less than 30 times a quarter. Subscribers also receive real-time news and prices, and other tools such as advanced charting. More active traders pay less.

Level 2 data is included free in the Power E*TRADE account, available for those who trade more than 30 times a quarter.

One way to use the power of the Level 2 data is via a broker offering direct market access (DMA), by which private investors can place buy and sell orders on the LSE’s central limit order book. This enables trading of SETS and SETSmm stocks directly with other participants, rather than having to go via a market maker and pay the spread. Only iDealing.com and Interactive Brokers currently offer DMA to UK share traders.

Gerald Perez, MD of Interactive Brokers (UK), says that in the current volatile conditions traders want to be able to participate on an equal footing with the professionals. ‘Our Smart Order Routed DMA platform allows clients to view live data, get in on either side of the bid and ask, or improve on the order book. We support sub-second fills, with clients able to use various sophisticated order types to trade the book.’

Interactive Brokers charge £6 commission for each UK equity trade up to a maximum value of £50,000. There is also a monthly fee for the market data, which varies per product/exchange. Commission at iDealing.com is £10, although discounts are available by pre-purchasing, and there is also a charge of £2.20 for each partial fill on the order book. The only other fee is the quarterly administration charge of £5.

The benefits of DMA are also available via a CFD account. This also offers the ability to trade on margin and to sell short to profit from falling prices. Those who want this will need to sign up to a CFD service from the likes of E*TRADE Securities, GNI Touch or IG Markets.

When a client places an order to trade a UK equity CFD, the company will create the equivalent position in the underlying cash market to hedge the exposure. This mirrors the client’s instruction in price and volume and is entered on the central limit order book as seen on the Level 2 screen.

Direct market access CFD providers normally charge commission of 0.2% or less. This means the combined cost of the opening and closing legs of the trade is normally less than the stamp duty when buying the shares direct. The only other expense connected with the CFDs is the financing charge on long positions held open overnight.

The main reason most people sign up to a DMA service is to avoid going via a market maker and hence not having to pay the spread. If a stock is trading at 200-204, someone using a traditional broker would have to cross the spread by buying at the offer of 204 and selling at the bid of 200. On a round-trip trade of 5,000 shares this would cost £200.

Alex Orban, vice president of UK Retail for E*TRADE, says volatile share movements in established old economy sectors have boosted DMA trading. ‘Clients can use adverse price movements by placing their orders directly on the order book at desired limits. A client can also make the market by placing an order to buy at the bid price and sell on the offer.’

A DMA trader looking to buy could try and improve on the price by entering a bid at 200. This would join the best-priced orders and could be executed; or the trader could place a bid inside the spread at say 201, which would temporarily be right on top of the order book ready for the next fill.

Favourable entry and exit

DMA traders can enter their bids and offers at any prices they want irrespective of where the stock stands, so they can place orders in a gap on the book a little further away from the current price. The normal market noise will often be sufficient to fill these at some point during the day.

‘In a fast-moving market, client orders can be filled if there is enough demand at the client’s limit on the order book,’ says Orban. ‘As the order book works on an automated matching basis, orders can be executed in a split second. In high volatility this strategy can be invaluable.’

Stockbrokers have sometimes been unable to obtain quotes for clients via the traditional quote-driven system because, in a fast market, or where there is a lot of interest in a stock, the market makers may significantly reduce the size of the electronic orders they will accept. The alternative is to phone the broker, who will ring round the market makers, but this can take time, which can be expensive when the price is moving quickly.

Gary Duckworth, business development manager at iDealing.com, says DMA allows traders to be dealt with before the price moves further. ‘In the past few months we have seen examples where it has been difficult to trade via a broker using a quote-driven system.’

One advantage of DMA is that it enables traders to participate in the LSE’s opening, closing and intraday auctions, when a stock often records its day’s high or low, which means only those with DMA have the chance to get filled at the best prices.

Tim Hughes, head of sales trading at IG Index, says investors with DMA can steal a march, as those without must wait for conventional trading to resume. ‘When a company issues its results ahead of the opening, if they are likely to lead to a significant move, a DMA trader could look to place an order in the auction so as to get in at the official opening price for the day.’