What Is the Difference Between a Broker and a Dealer?

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If you want to buy fresh fruit, you would probably travel to a nearby grocer or even a local farmer's market. Both of these locations solve an essential problem that exists for buyers and sellers in any marketplace; connecting to one another. In some markets, however, making this connection isn't always as easy, and specialized occupations, ones with a goal of aiding traders in trading with one another, frequently appear.

Understanding the Marketplace

  • Whether a marketplace exists for fruit or stocks and bonds, the fundamental basis for them all is the buyer (someone who wants to obtain a product or service as inexpensively as possible) and a seller (someone who wants to obtain the highest possible price for a product or service he sells). In between these players can appear brokers and dealers, who may serve the needs of buyers or sellers alike.

What Brokers Do

  • A broker works for a client, who may be either a buyer or seller. The broker's job is to locate other traders willing to complete a transaction with his client. Brokers often are paid through commission--a percentage of the value of the transaction, for example--but in some cases may receive a flat fee for each successful transaction they arrange.

The Value of Brokers

  • A broker often has connections and insights into a marketplace that his client may not. Knowledge of other traders, and their habits, allow a broker to locate new clients for himself and successfully arrange transactions for them. In some cases, a broker may have special access to markets or market players that a client could not hope to assemble for himself, thereby bringing value by opening up trade possibilities that would not otherwise exist.

What Dealers Do

  • Dealers play a role as both buyer and seller and ultimately hope to profit from the differences in their transactions with other market players. Dealers primarily exist in markets where products, and not services, are exchanged. In some cases, dealers work with other dealers from distant marketplaces in the same way they work with local buyers and sellers, and profit by trading on disparities that may exist between the two markets.

The Value of Dealers

  • Dealers maintain an inventory of products so that they may trade with a buyer when a buyer requests. At the same time, a dealer is also willing to purchase products from a seller when a seller wants to trade. In essence, a dealer solves the problem of actually trading for both buyers and sellers and helps provide a fluid and active market for all participants. They can be particularly useful in markets that have few players and are therefore not consistently active.

Broker-Dealers

  • Some market players may act as both a broker for clients and as a dealer for themselves. These market actors are known as "broker-dealers" or "dual traders." This allows them to act as a trading agent for a client, thereby earning a commission on the trade while increasing or decreasing their inventory at a profit, simultaneously. However, internalizing client trade orders often generates a conflict of interest, as the broker-dealer wants the opposite, in terms of price, than does her client.

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References

  • "Trading & Exchanges: Market Microstructure for Practitioners;" Larry Harris; Oxford University Press, 2003
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