Duration: 4:04
Level: Beginner

This lesson covers the types and responsibilities of brokers and investors.

Contributed By: IEX

Study Notes:

Welcome back again to our introduction to US equity market structure. Now that we’ve set up the rules of the playing field and the ball, how does trading really happen?


Investors are the ultimate stakeholders in the market.

  • They’re who the SEC was set up to serve.
  • They’re the ones whose capital is invested in companies giving them the resources they need to grow and drive the economy.

Investors include individuals as well as institutional asset managers who in turn pool the money of individuals through:

  • Mutual funds
  • Pension funds
  • RIAs
  • Etc.

and invest it on their behalf.

If you’re investing in a company, you may be considered an investor. If you have a 401(k), you’re an investor.

Surveys suggest that about half of Americans are invested in the stock market in some way. So, in one way, investors are the players on the field.

They research companies; they own stocks that go up or down in value; they decide whether to buy or sell.

Investors stand to win or lose depending on how the market moves in relation to their positions. Despite the centrality of the investor in the market, though, many investors can’t actually trade directly themselves. When you go on your trading account and place a trade, for instance, you aren’t actually placing your order directly on a stock exchange. Instead you’re entrusting your order to a registered broker-dealer which executes the trade on your behalf in line with your instructions.

Broker dealers

In that sense, broker dealers are the actual players on the field.

Broker dealers are firms that are registered and approved to buy and sell securities.

Broker or agency broker dealer refers to a firm or person that executes trades on behalf of a client.

Dealer or principal trader refers to someone who buys and sells on their own account.

Of course, many broker dealers do both.

There are a few more specific kinds of broker dealers you may encounter:

Prime brokerage refers to a broker that adds services like:

  • Securities lending
  • Leveraged trade executions, and
  • Cash management

Large investors often need these kinds of services.

Proprietary traders are market participants that trade mainly for their own accounts. In some case, the group known as “High speed traders” are proprietary traders. Because they don’t have responsibility for client orders, they often have more flexibility on how to trade and can take on more risk.

Retail broker dealers are brokers who serve retail investors – typically individuals who want to buy and sell stocks

Responsibilities for brokers

I mentioned previously that brokers have responsibilities to their investor clients when they trade on their behalf. Those responsibilities are quite broad, but we’ll just cover a couple here:

First, brokers owe a responsibility of “best execution” to their clients.

According to the SEC, this means that they’re quote “legally required to seek the best execution reasonably available for their customers’ orders.”

Defining what executions are the best and what is reasonably available are both heavily discussed topics in the industry.

At the very bare minimum, it means that brokers can’t execute orders at a price that’s inferior to a displayed quote available somewhere else in the market. But it is also understood to mean that brokers should try to get price improvement when possible – meaning a price better than the prevailing best price displayed in the market.

Second, which brings us to a second responsibility of the broker: “order routing”.

Brokers send their clients’ orders to different venues in the market to be executed And when the client doesn’t give explicit directions around where to route orders, the broker has significant discretion around where to send the order.

According to Rule 606 of reg NMS, brokers must regularly report where they send orders for which the clients haven’t given those explicit directions.

You can easily Google 606 report and a broker’s name to find these quarterly reports.

While all broker dealers are presumably trying to get a good execution on their trades different kinds of broker dealers have different priorities depending on whether they represent themselves or their clients, and if they represent clients, what their priorities and instructions of their clients are. These differences are what should determine their strategies and tactics for trading, which is what we’ll discuss in our next lesson.

Note that videos were recorded in December 2019.

“IEX and Interactive Brokers undertake no duty to update the information contained herein, and the information is provided for informational and educational purposes only.”

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