11:11 PM, 23 Mar 2017 (AUS EDT)   The market is currently closed       

CFD Types: Direct Market Access (DMA) VS Market Maker (MM)

Two major types of CFD models exist. One is called Direct Market Access (DMA), and the other is termed Market Maker (MM). They each have their own advantageous and disadvantageous. But before we discuss the pros and cons, what do the two models DMA and MM really mean?

Direct Market Access

Contracts For Difference can be traded by the Direct Market Access method. This means that the CFD order is placed in an order book with buyers and sellers trying to get the prices at the bid and ask. Buying and selling a CFD in this manner will influence the share price of the underlying asset. The CFD price will be directly related to the current market price and will be influenced by asset liquidity.

Direct Market Access allows for complete transparency of transaction with no middle man adjusting prices – just you and the open market.

Market Maker

Trading through a middle man, or a Market Maker, is another option available. His pricing, while claiming to mirror market prices, will often be slightly less competitive to allow for the Market Makers profit. Transaction times might also be slower from adding another leg onto the transaction.

Essentially, he takes the real market and then using it as a baseline, creates his own. He is not really trading with the market but has created his own synthetic market.

Pros and Cons

Each method has its own unique advantageous and disadvantageous ranging from competitive price and transparency, to the amount of choice.

  Direct Market Access on ASX CFD’s Market Maker on OTC CFD’s
Transparency and Pricing The DMA model has complete transparency whereby the purchaser of the CFD can determine his exact entry and exit values. Having a middle man to execute your orders will create a degree of separation. He has the ability to set his own prices and market, although they are still somewhat based on market prices.
Structure Based exactly on market values. Mirroring closely to market values.
Market Liquidity Based on the market. Can sometimes provide better than the market.
Influence on share prices? Trading DMA CFD’s will make the share price go up or down. Trading MM CFD’s will not affect the current market share price of the asset.
Profits Made by Portal? Because this position is 100% hedged, the Direct Market Access makes money from the transaction fees only. The Market Maker does not need to completely hedge his position. This means he may profit as a direct result of your loss or your profit.
Speed of Transaction Quick and Direct Somewhat slower due to price being re-quoted and at discretion of dealer
Markets Offered? Usually limited to the top 50 stocks on the ASX plus a few other limited offerings. Ability to offer international investments and currency pairs

This may appear like a complete slam-dunk against the Market Maker model. But under certain circumstances an individual may choose to trade with the MM system. Let’s examine this a little further.

DMA vs MM?

Most people trading the top stocks on the ASX will choose to use the Direct Access Model. They will receive a more competitive price, quicker transactions, and less manipulation. A trader using the DMA needs to only worry about his strategy and timing, without suspicion of the big bad wolf trying to undermine his every trade.

However, certain traders will choose to use the Market Maker for another reason. Perhaps they want to trade not only the more commonly offered securities but some of the more exotic ones as well. Maybe they also want to speculate on International exchanges, spot prices on precious metals, currencies, energies, interest rates, and bonds. While the ASX CFD’s may provide limited options with these, the Market Maker may provide a wider array of options. Also, in theory the MM may be able to provide a lower initial transaction fee since he is dealing with a synthetic market and not placing orders in the ASX trade book. This is in theory only, since there are many other ways to pad the transaction.

As well, liquidity with the DMA model is directly related to market liquidity. When dealing with a very illiquid asset, acquiring CFD’s might prove to be costly and difficult. The Market Maker does not need to physically purchase the asset, which works around the liquidity problem. You can take up a very large position with an ‘over the counter’ CFD on an illiquid stock without affecting the price any.

Keep in mind that this article is comparing ASX CFD’s as the DMA model, and OTC (Over The Counter) CFD’s being the tool for Market Makers. If a trader wants the best of both worlds, he has the option to use Direct Market Access with Over the Counter CFD’s, which transactions are sometimes dubbed Straight Through Processing (STP) or ‘over the counter’ DMA as opposed to MM.

Final Word on Direct Market Access and Market Makers

Whether a trader wishes expose himself to the potential risk and reward of a Market Maker is up to him. But clearly understanding the pros and cons of each method will at least make him aware the associated risks with Market Makers, and whether the advantages in his particular case outweigh the negatives.

For most new CFD traders, they will likely choose to trade ASX CFD’s, or ‘over the counter’ CFD’s where the order is placed in a trade book and not through a Market Maker.