Broker-dealers play an important role in the stock trading system. They provide investors and traders a point of entry into the financial markets.
As an investor, you need to do business with broker-dealers to access investment opportunities and meet your long-term investment needs.
Broker-dealers come in all shapes and sizes, so it’s important for you to know how to evaluate which one is right for you. Here’s what you need to know:
— What is a broker-dealer?
— What is a broker?
— What is a dealer?
— Differences between broker and dealer.
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What Is a Broker-Dealer?
Broker-dealers are firms or businesses that buy and sell securities like stocks, bonds and mutual funds for their customers.
“Commonly referred to as a BD, a broker-dealer is a licensed person or firm that acts as an intermediary for buying and selling securities on behalf of its customers,” says Dan Raju, CEO of trading and brokerage platform Tradier.
Broker-dealers provide account management services and record-keeping services for traders’ accounts. For investors or traders to participate in the stock market, they have to open an account with a broker.
“Online brokers, or online BDs, provide retail investors (with) a digitized experience to open accounts and facilitate the execution of trades for customers,” Raju says.
Companies like Charles Schwab (ticker: SCHW), E-Trade and TD Ameritrade are known as broker-dealers that provide their users with online access to the markets.
When you want to buy an asset, you tell the broker what you want to buy and they execute that trade through an exchange.
“Broker-dealers facilitate trades on a trading platform, which is software that enables investors and traders to place trades and monitor accounts through financial intermediaries,” says Anthony Denier, CEO of trading platform Webull.
These platforms, Denier says, offer features including real-time quotes, charting tools, news feeds and research. “Some platforms offer access to many specific markets, while others focus on just one, such as stocks, bonds, forex or cryptocurrencies,” he says.
The broker also keeps track of these transactions and executes trades on the customer’s behalf in exchange for a commission.
A majority of broker-dealers are regulated by the U.S. Securities and Exchange Commission and are members of the Financial Industry Regulatory Authority, or FINRA. As registered financial professionals, they are required to pass financial examinations and be licensed by state securities regulators to do business.
Given that there is a lot of capital moving through broker-dealers, there are financial regulatory authorities that oversee their activity, such as FINRA. This institution ensures broker-dealers are operating in a way that protects investors through audits and oversight.
“The regulations are important because they ensure that public markets are working to protect the consumers and maintain a high level of truthfulness, fairness and transparency about their businesses and the risks involved with investing,” Raju says.
[SEE: 7 Best 5G Stocks to Buy in 2021.]
Brokers
A broker is someone who acts as an intermediary between investors and a securities exchange, facilitating transactions of publicly traded companies.
Most brokerage firms are broker-dealer firms. Brokers can be individuals or companies that conduct transactions on behalf of clients in exchange for a commission. Some of the well-known stock brokerages include Fidelity, Schwab and E-Trade.
If you want to buy or sell a stock at a certain price, a stockbroker will execute those orders for you. A stockbroker will simply facilitate your investment decisions on your behalf. In the past, human brokers facilitated trades. But today, retail investors use technology to quickly put in trades without any human interaction.
If you are an everyday investor who wants to participate in the stock market, you will likely open an account with an online broker. With brokerage firms like Robinhood, TD Ameritrade, E-Trade and others, you can easily open an account and put in electronic buy and sell orders. The broker takes your orders and makes money from commissions and other fees on trades you make.
When you open a brokerage account, you have the choice to go with either a discount broker or a full-service broker. A discount or online broker is a cheaper way to invest. This type of broker, which has come to be known as a robo advisor, operates through automated investing on the platform’s algorithm and tends to be more cost-effective with lower fees. There is no human interaction.
A full-service broker offers more products and services to their clients compared to a discount broker, including research on sectors, personalized advice, and facilitating the buying and selling of financial securities. Full-service brokers need to be up to date and knowledgeable about what’s going on in the market since they make investment decisions on their clients’ behalf.
Given that a full-service brokerage offers a customized approach to investing, this translates to higher fees compared with a discount broker.
When shopping around for a broker, Ami Shah, CEO of financial planning app Steward, says to look for “three bright lines in the sand,” which include a clear statement that they’re a fiduciary, someone who doesn’t promise you too much too soon and someone who has had the same customers for more than five years.
[READ: How to Invest Using Sector Rotation.]
Dealers
Unlike a broker who acts as an agent facilitating trades of securities on behalf of others, a dealer is a broker who executes the trades and acts as the principal or person who buys and sells securities for their own account. In other words, they have their own interest in buying and selling securities.
The reason it’s easy to move in and out of trades is because of the job of market makers. Dealers act as market makers when they place bid and offer prices. Market makers set bid and ask prices according to the supply and demand of the asset in the market. This determines the bid, or the price at purchase, and ask, or price to sell spread. Market makers will purchase assets and sell them at a higher price to secure a profit. The way they make money is by maintaining a spread between the bid and ask price of the asset. This activity helps provide liquidity to the stock market.
They’re making a market in securities, Denier says. “It can be selling products from its own inventory to clients or buying securities when clients want to sell,” he explains.
To hedge their risk, market makers must be keenly aware of market conditions and volatility, says Stephen Akin, founder and advisor at Akin Investments.
“They may deploy strategies on various types of indexes that could be closely in tune with the issues that they are trying to make the market in, as well as consideration for market volatility,” he says.
Differences Between Brokers and Dealers
People may use broker and dealer interchangeably, but there are several elements of distinction. These include the following:
— Brokers act as the middleman, bringing together buyers and sellers.
— Brokers trade on commission by bringing in customers and facilitating orders for a fee.
— Brokers are companies that execute trades for customers trying to make affordable transactions.
— Brokers can offer research tools for their customers to provide more value.
— Dealers enter and fill the orders for customers or on their own behalf, acting as a principal to take on risk with their own capital.
— Dealers become market makers, matching sellers to buyers and maintaining a spread through their bid and ask price of a security.
— A dealer market helps provide liquidity in the market for investors.
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What Is a Broker-Dealer? originally appeared on usnews.com
