The retail brokerage business was disrupted when several major retail brokerages such as Schwab, E*Trade, and TD Ameritrade announced commission-free stock trading. While choosing such brokerages is a matter of course for long-term investors, the question arises for day traders whether they should choose a retail broker or a direct-access broker.
In this article, I’ll clarify how retail brokers and direct access brokers compare in the 6 most important categories and how traders can make the most fitting brokerage decisions based on their personal trading style.
The investor pays commissions to the brokerage for order handling. The broker routes the client order to the stock exchange.
Retail Broker: All major U.S. retail brokerages offer 0 commission trading for stocks these days. The broker takes care of the order-routing process. Even 1 share can be bought with 0 commissions to be paid.
Direct Access Broker: Direct access brokers charge commissions typically from $0.002 to $0.005 per share. Clients have full control over the order routing and can route their orders directly to NYSE, NASDAQ or an electronic communication network (ECN). There’s often a minimum commission of $1 per trade.
Buy and sell orders are typically executed within a fraction of a second. The speed of order execution is essential for day traders and high-frequency traders. The closer the brokerage servers are located relative to the stock exchange servers, the better.
Retail Broker: Retail brokers have massive data centers that handle order routing for millions of clients every day. The order execution is incredibly reliable, and not even the slightest delay has a meaningful negative impact on the long-term performance.
Direct Access Broker: Direct access brokers are well known for their exceptional high-speed trade execution. Execution that’s even a fraction of a second faster makes a big difference to a day trader's overall profit. If 10,000 shares are bought and sold within a few seconds, and the fast order execution leads to a fill that’s 2 cents better per order, the overall profit will be $400 higher.
Order routing is the big difference between retail brokers and direct-access brokers. Order routing defines where your order is placed and how the order will flow through the process.
Retail Broker: Retail brokers receive order requests from their clients. Each order then goes through an internal order routing process within the brokerage. The client can’t control the order routing process through a retail broker. The retail broker may sell the order flow to 3rd parties, match the orders with other in-house orders from other clients, or route it directly to the stock exchange. The order routing steps look like this: Order ➡ Broker ➡ Market.
Direct Access Broker: A direct access broker eliminates the extra step between the order placement and market. With a direct access broker, the order routing steps look like this: Order ➡ Market. This process ensures higher-speed executions. Direct access brokers also allow their clients to choose a specific stock exchange or ECN where they want to have their trade executed. A particular order routing is also beneficial since some exchanges and ECNs provide rebates of about $0.002 per share if traders provide liquidity (e.g., with limit orders). That said, traders who take liquidity (e.g., with market orders) might also pay a fee of about $0.002 for doing so.
Investors and traders need a trading platform to manage their investment and trading activities. Most brokerages offer web-based platforms, apps, and local software installations.
Retail Broker: Retail brokers like TD Ameritrade and Charles Schwab have developed excellent trading platforms for their clients. Most clients probably use only 1% of all functionalities and features that these platforms have to offer. Most of the platforms focus on charts, technical analysis, and excellent self-explaining navigational elements. Everything is integrated and all types of investors can use the software to their advantage. In most cases, the platforms are free to use.
Direct Access Broker: Direct access brokers often have an in-house solution and offer access to popular trading platforms like Sterling Trader. Such trading software solutions are made for active traders focusing on high-speed execution and hotkey trading. Unlike retail broker software, subscription costs for this type of trading software can go as high as $300 per month.
Market data enables investors and traders to see the current stock prices in real-time or delayed by no more than just a few minutes.
Retail Broker: Retail brokers offer their clients free, real-time, level 1 data for the U.S. stock markets. The best bid, best ask, and last price are all available in the real-time data, as well. Access to level 2 data with order book depth is available for about $10, depending on the broker used. The data can be considered reliable, but some brokers only transmit a specific amount of data to the client's software to ensure stability and preserve IT resources. That said, it makes no meaningful difference to long-term investors whether or not a data stream is based on filtered tick data.
Direct Access Broker: Traders are required to pay for all kinds of market data when using a direct access broker. The pricing for private investors in the stock market could be considered manageable, with about $1.50 for Nasdaq Level 1, Pink Sheet Level 1, and Arca Book for $15 per month. The unfiltered tick data and low latency server location close to the stock exchange, along with direct order routing, give the client an edge that may lead to better order fills.
Customer Support takes care of client requests regarding their brokerage account or current orders.
Retail Broker: Retail brokers have a team of employees who take care of client requests, often 24 hours a day. These days, waiting times of 60+ minutes are typical for retail brokers.
Direct Access Broker: Direct access brokers have a small team of specialists available to directly answer the phone and take care of client requests within minutes, sometimes even seconds.
Retail brokers and direct access brokers both exist for good reasons and with different types of commission structures. Long-term investors and low-volume traders are well-advised to choose a retail broker. A retail broker opens the door to the world of investing with low account minimums of $2,000 or less, free access to extensive learning material, and free access to the trading platform with market data included. Another massive benefit of using a retail broker is the availability of simulated trading.
Direct access brokers are more expensive. Clients must pay commissions, buy the trading platform and market data, and the account minimum is often $30,000 due to the pattern day trader rule. A direct access broker is beneficial for those looking for the fastest possible trade executions, specific order handling, and readily available customer support. The point is, if you’re long 10,000 shares in a highly volatile stock and your order gets stuck, you can bet that you’ll want to have someone on the phone within seconds instead of waiting 60 minutes.
While there’s no right or wrong when it comes to choosing a broker, knowing the best fit for your trading style will benefit you in the long run.