The broad basics of trading financial securities like stocks is easy: One entity sells, and the other one buys. But how do those two come together to make a deal? Often, they need a matchmaker. This is where brokerage firms come in as an intermediary.
What is a brokerage?
A brokerage is a financial company that acts as a facilitator to make trades happen. They connect buyers and sellers to facilitate trading of financial securities such as stocks, bonds, options, and other investments.
Some brokerage companies offer additional services such as investment advice and research reports. Others are “discount” brokerages with more bare-bones services, offering lower costs for customers who want just trade facilitation and not much else.
What does a brokerage firm do?
The core function of a brokerage firm is to serve as an access provider to trading venues. Trading venues (or “exchanges”, like the NYSE, NASDAQ, ASE etc) match buyers with sellers of securities.
When a person or organization wants to buy or sell a security, they place an order via their broker. This can be completed through an online trading platform, a core option for clients of discount brokers, though some full-service firms also offer online platforms — or by speaking directly with their broker or a representative.
Brokers may route trades to a venue best suited for a particular trade. Some trades could be executed on a public exchange (like NYSE, NASDAQ or the ASE) and others may be routed to an Over-The-Counter (or OTC) venue. It’s then the broker’s job to find the most suitable venue for that trade. If their client wants to sell a stock, for example, they look where that security is listed or if such a trade requires to be executed OTC. The broker’s ultimate goal is to facilitate the trade for their client at the best possible price.
How do brokers work?
How exactly a match is made depends on the security in question. Generally, though, trading brokers scour market data to figure out the current market price and take into account details like the trading volume of that security.
Brokerages often leverage technology like proprietary algorithms and specialized trading systems to help them find a good match—something that happens automatically with online brokerages. Full-service brokerages also often tap their personal contacts within the industry.
It’s easier to find a so-called counterparty to execute a trade in certain cases compared to others. For example, a broker would likely easily find a trade for a highly liquid security like a stock that trades on one of the major exchanges.
But trades of more unique or specialized securities may take longer, or may even ultimately not be executed—such as securities like certain kinds of bonds or private-equity investments that trade on smaller markets with less volume, as well as more complex instruments like some types of derivatives.
A broker with a client who’s willing to trade only at a specific price or delivery date may have a tougher time finding a counterparty who’s willing to meet those requirements.
3 types of brokerage firms
1. Full-service brokerage
A full-service brokerage, such as Fidelity, Edward Jones, and Morgan Stanley, is a financial company that offers a wide range of investment services beyond mere trade execution. These firms provide financial planning, portfolio management, personalized investment advice, and access to research and analysis tools. Full-service brokerages collaborate closely with clients to tailor investment strategies according to individual goals and risk tolerance. Despite charging higher rates, clients benefit from the expertise and holistic approach, receiving not only transactional support but also guidance.
2. Discount brokerage
The difference between full-service and discount brokerage firms is that discount firms are often online-only brokerages, and they may let clients buy and sell securities themselves. Investment or portfolio advice is typically excluded, and their fees are lower than full-service brokerages. Examples of discount brokerage firms include E-Trade, Webull, and Public.
3. Robo-advisor
Robo-advisors are online investment platforms that provide investment advice and manage portfolios, but do so by leveraging algorithms customized based on client needs. Fees tend to be higher than discount brokers but lower than full-service for these firms, which include Betterment, Ellevest, and WealthFront.
How does a brokerage firm make money?
Brokerage firms and the individual stockbrokers they employ make money in a few ways. They have to balance the need for profit with the client’s desired trade parameters, current market conditions, the available counterparties, and more.
Commissions
In some cases, when a broker executes a trade for a client they may earn a commission based on the amount of the transaction. This may be a fixed per-trade fee, or calculated as a percentage of transaction value.
Fees
Some brokerages charge several different types of service fees, including for account maintenance, transfers, or trades of certain investment products.
Indirect revenue sources
Brokerages may earn revenue from indirect sources like interest on client funds, lending securities, and other activities. Similarly, brokerages may earn from routing a large volume of their clients’ trades to a particular venue, called payment for order flow.
How do stockbrokers make money?
Individual stockbrokers may earn commissions and other forms of compensation like bonuses based on their sales performance or signing on new clients. Contracts and salaries can differ based on the brokerage.
Questions to consider for a brokerage account
● Do I want someone to manage my portfolio for me?
● If I need to pull money out, do they offer instant payouts or will I be waiting a while?
● What fees and commissions do they charge?
● Which investment options does the brokerage account offer?
● What trading technologies and other tools do they leverage?
● What level of customer support do I need?
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