Most people have heard the term broker and usually associate it with financial markets, but what is a broker, and do you need one?
There are numerous types of brokers serving various industries, primarily investment brokers, insurance brokers, and real estate brokers. Regardless of the industry, a broker is an individual or firm acting as an intermediary between two parties.
A broker is not always necessary, and we will give a broker example below. In most industries where a broker operates, it is either impossibly or inconvenient to deal without one.
What is the Broker Meaning and Who is a Broker?
A broker usually represents the seller of an asset or acts as the intermediary between a buyer and seller. In the ongoing debate between broker vs. market maker, especially in broker forex discussions, an online broker can function as both, creating a conflict of interest, partially to blame for the bad reputation the online broker industry received.
A broker is either an individual or a firm, matching buyers and sellers and receiving a commission. A broker may also receive compensation from a securities exchange for providing liquidity. In some industries, buyers and sellers can engage without a broker, but often, a broker is necessary.
For example, buying stocks on an exchange requires a broker, as it does not accept orders from non-members. A broker in the Forex market offers the trading infrastructure and order execution. While individuals could exchange currencies manually at their bank or via an exchange office, it results in an inefficient trading approach.
Before the rise of online brokers, expensive full-service brokers were the only way to buy and sell stocks, and banks conducted most of the Forex trading. The emergence of online brokers changed the landscape, significantly increased accessibility, and lowered trading costs.
What Does a Broker Do?
In the broadest sense, a broker enables transactions. A broker is a go-between facilitating order flow, either by matching buyers and sellers or creating a market. Since a securities exchange does not allow individuals to connect directly to its servers to buy and sell assets, a broker is necessary for traders and investors to place orders.
Most opt for online brokers, sometimes known as discount brokers, where costs are lower. They started to displace brick-and-mortar brokers, which are expensive, but pride themselves on an individualized approach.
Some brokers maintain an inventory of stocks, which lowers transaction costs and speeds order execution. Others work with several liquidity providers to find the best buying and selling prices but have no internal inventory. Most retail orders are never routed to an exchange or market, as brokers attempt to fill them internally between clients.
Brokers usually have a fully automated system with human supervision that matches orders and manages inventory.
Different Types of Brokers
Most people associate a broker with investments, but many industries rely on brokers, ensuring efficient and convenient transactions.
Here is a list of brokers:
- Investment Broker
- Stock Broker
- Forex Broker
- Broker-Dealer
- Prime Broker
- Commodity Broker
- Options Broker
- Real Estate Broker
- Mortgage Broker
- Insurance Broker
- Information Broker
- Ship Broker
Many other types of brokers exist. Some brokers, for example, in financial markets or real estate, require a license, which requires passing several exams. Other industry-specific brokers have no professional requirements and conduct on-the-job training.
The broker vs. exchange difference
An exchange maintains the listings of assets and ensures regulatory compliance and order flow. A broker is an exchange member, connecting individuals and companies to exchanges, allowing order placement and portfolio management. One cannot exist without the other, and exchanges charge membership fees but compensate brokers for providing liquidity.
What is a broker in Forex?
Forex trading is decentralized and over the counter, and a centralized exchange does not exist. A Forex broker maintains the trading infrastructure, trading platforms, price quotes, assets, and order flow. It is a one-stop solution ensuring traders can access the 24/5 Forex market.
Does a Broker Make Money?
Brokers are compensated for their services. Depending on the industry and work quantity, their fees can range from above-average to lucrative, highly dependent on volume to remain competitive with lower costs.
How does a broker make money?
Most brokers charge a commission on the transaction value, but there are other ways a broker can earn money.
Here are the most common ways a broker makes money:
- Commission on transaction values, often with a minimum fixed commission, and then a percentage-based value
- Commission-free brokers are generally more expensive, as they increase costs elsewhere, known as hidden costs, for example, in trading, they increase mark-ups on spreads and financing costs
- Spreads, the difference between the buying and selling price, is another core income generator for brokers
- Liquidity providers and exchanges pay a fee to brokers for adding liquidity
- Brokers may sell orders to market makers unless they function as a market maker, in which case a broker profits directly from client losses, walking a fine line with careful wording to make it appear as if a conflict of interest does not exist by replacing humans with computers
- Interest on cash balances of clients, where most brokers earn money but fail to share it with clients, as noted in their terms and conditions
Broker Examples for Investors and Traders
Here is a broker example with an in-house order match:
- Assume you want to buy 25,000 shares in a company
- You place a buy order with your broker
- The broker scans its internal order book and finds two clients selling shares in the company you want to buy, matching the order, and charging a commission to both
Here is a broker example with a partial in-house order match:
- Assume you want to sell 5.0 lots in the EUR/USD
- You place your sell order with your broker
- The broker has four clients seeking to buy and combines 3.5 lots and fills the order, charging both a commission
- It then places the remaining 1.5 lots on the market, sells it to a market maker, or takes the position if the broker is the market maker
Here is a broker example with external order placement:
- Assume you want to buy 25,000 shares in a company
- You place your buy order with your broker
- The broker, or rather the computer system, scans its liquidity providers for the lowest buying price and matches your order at the best available price
- You pay the broker a commission, and the broker earns a fee from the liquidity provider
What are the Requirements to Become a Broker?
It depends on the industry, but a license, granted after passing several exams, is necessary in some cases, like financial and real estate brokers. A background in finance is beneficial but not necessary, while other industries have no professional requirements and train brokers on the job.
Broker or Brokerage, what is the Difference?
A broker is often an execution-only broker, allowing clients to place orders and manage portfolios. A brokerage offers value-added services, like market research, investment advice, and trading recommendations. A brokerage may also feature a liquidity service, a prime brokerage unit, and an in-house technology development team.
Noteworthy:
- Most brokers today are discount brokers, offering lower costs, trading tools, and educational resources
- Robo-Advisors are discount brokers or FinTech firms offering algorithmic trading advice and portfolio management
- Full-service brokers are old-school, traditional brokers offering expensive managed accounts with human supervision
- Understanding the broker meaning will help clients find the best broker for their needs
Broker Conclusion
A broker is an individual or firm connecting buyers and sellers. Some industries, like finance and real estate, require a broker, others can function without one, but the absence can create inefficiencies. A broker usually gets paid a commission, and traders should avoid the commission-free trap of brokers, where costs are generally higher than commission-based brokers.
FAQs
How do I become a broker?
Depending on the industry, either by passing exams and acquiring a license or via on-the-job training.
Why do we need brokers?
Brokers match buyers and sellers, and several industries cannot function without one. They also ensure an efficient order flow and a stable market infrastructure.
Do brokers make a lot of money?
It depends on the quantity of their work, but brokers in finance usually maintain a financially attractive business model.
Can I buy shares without a broker?
Buying shares without a broker from an exchange is not possible.