Stock Broker: Definition, Types of Brokerage Firms

What is a Stock Broker?

A stock broker, also known as a securities broker, is a financial professional or a firm that is licensed and authorized to buy and sell securities on behalf of their clients. These securities can include stocks, bonds, mutual funds, exchange-traded funds (ETFs), options, futures, and other investment instruments.

When stock brokers are financial institutions or companies that employ stockbrokers and provide a platform for clients to trade various financial instruments, they are also referred to as Brokerage firms, or simply as brokers.

When companies decide to list their stocks on stock exchanges, they transform their ownership shares into publicly traded securities. This means that these securities are available for anyone in the general public, whether individual or institutional investors, to buy and sell.

However, investors cannot directly engage with stock markets or exchanges. They cannot simply walk into a stock exchange and start trading. Instead, they rely on the services of stock brokers or brokerage firms, which essentially act as financial intermediaries connecting clients – who may be individual investors, institutions, or traders – with the financial markets.

Stock brokers offer a wide range of financial services, which can include:

• Buying and selling of stocks, bonds, and other securities on behalf of clients.
• Providing research and analysis to help clients make informed investment decisions.
• Offering trading platforms and tools for clients to execute their orders.
• Managing client accounts and portfolios.
• Providing investment advice and recommendations.

Stock brokers offer various types of accounts, such as individual accounts, joint accounts, retirement accounts (e.g., IRAs), and corporate accounts, to meet the diverse needs of their clients.

They earn commissions, fees, or spreads on transactions. Their compensation structure can vary, with full-service brokers charging higher fees for more comprehensive services, while discount brokers charge lower fees for executing trades with minimal advisory services.

Stock brokers are subject to regulatory oversight by government agencies, such as the U.S. Securities and Exchange Commission (SEC) in the United States. They must adhere to industry regulations designed to protect clients and maintain market integrity.

What does a Stock Broker Do?

A stock broker plays an important role in the financial markets, acting as an intermediary between clients and the stock exchange or other trading platforms.

Here’s a breakdown of what a stock broker does:

1. Client Consultation

The process begins with a client seeking the services of a stock broker. The client may be an individual investor, an institution, or a trader.

A Full-service broker usually starts by understanding the client’s financial goals, risk tolerance, and investment preferences.

Discount brokerage firms, including online brokerage firms, omit the client consultation step that is typically associated with full-service brokerage firms.

2. Account Setup

Once the client’s goals and preferences are understood, the full-service broker helps the client set up a brokerage account. This account is necessary to participate in the financial markets. The client may need to provide personal information, financial details, and identification documents.

For discount brokerage firms, this can often be done online through the brokerage’s website. During this step, clients provide the necessary personal, financial, and identification documents.

3. Research and Analysis (Investment Advice)

In a traditional full-service brokerage model, a client would consult with the broker or financial advisor to receive personalized investment guidance, recommendations, and advice. The broker would assess the client’s financial goals, risk tolerance, and investment preferences before making recommendations.

In contrast, discount brokerage firms are designed for self-directed investors. Online brokerage platforms offer various research and analysis tools, including real-time market data, stock screeners, charting tools, and news feeds. Investors can use these resources to conduct their own market research and make informed decisions.

4. Order Placement

Clients instruct the broker on what securities to buy or sell. The broker then places orders on the client’s behalf. These orders may be market orders (buy or sell at the current market price), limit orders (buy or sell at a specified price or better), or stop orders (execute a trade when the price reaches a certain level).

Investors using discount brokerage firms typically use the brokerage’s online trading platform to place orders directly.

5. Order Execution

Once a client places an order, the brokerage’s platform electronically routes the order to the relevant stock exchange or market. The order is executed at the best available price. The goal is to achieve efficient order execution and minimize trading costs.

6. Confirmation and Record Keeping

After an order is executed, full-service brokerages provide clients with order confirmation and transaction records. These records detail the execution price, quantity, and other relevant information.

Investors using discount brokers can access this information on the online trading platform itself.

7. Account Monitoring

After executing an order, the broker monitors the client’s portfolio. They track the performance of the investments and stay alert to any market events that may require portfolio adjustments.

In the case of discount brokers, clients themselves are responsible for monitoring the performance of their investments. They can access their account information, track their portfolio’s value, and review transaction history through the brokerage’s online portal or mobile app.

8. Reporting

Stock brokers provide clients with regular reports and statements detailing their portfolio’s performance, holdings, and transactions. This helps clients assess the progress of their investments. Investors can also access these reports through the broker’s online platforms.

9. Client Communication

Full-service brokers maintain open communication with their clients. They may provide market updates, investment ideas, or respond to client inquiries. The level and frequency of communication may vary based on the client’s preferences.

While discount brokerage firms do not provide personalized investment advice, they often offer customer support through phone, chat, or email to assist with account-related inquiries, technical issues, or general questions about the platform.

10. Other Functions of Brokers

Online Trading Platforms: Stock brokers provide access to online trading platforms. These platforms, which can be online or offline, allow clients to place orders, monitor their investments, and access real-time market information.

Regulatory Compliance: Stock brokers must comply with relevant financial regulations and ensure that their actions align with the client’s best interests. This includes adhering to industry standards, reporting requirements, and managing clients’ accounts in a compliant manner.

Compensation: Stock brokers earn compensation through commissions, fees, or spreads on transactions. Their compensation can vary depending on the services provided and the type of brokerage they work for.

Portfolio Management: Some brokers offer portfolio management services, where they actively manage clients’ investment portfolios. They rebalance holdings, select securities, and make investment decisions on behalf of clients.

Client Education: Some brokers educate their clients about investing and trading strategies. They may offer seminars, webinars, or written materials to help clients better understand the financial markets.

Types of Brokerage Firms

Brokerage firms or stock brokers come in various types to cater to different types of investors and trading styles. There are primarily three types of brokers.

1. Full-Service Brokerage Firms

Description: Full-service brokerage firms offer a wide range of financial services, including investment advice, research, portfolio management, and comprehensive financial planning. They typically have a team of financial advisors who work closely with clients to create tailored investment strategies.

Client Base: Full-service brokers typically serve high-net-worth individuals, institutional investors, and clients who seek personalized financial guidance.

Fees: They charge higher fees or commissions for their comprehensive services.

Examples: Merrill Lynch, Morgan Stanley, UBS, and Wells Fargo Advisors.

2. Discount Brokerage Firms

Description: Discount brokerage firms primarily focus on executing securities trades on behalf of their clients. They offer minimal investment advice and do not provide comprehensive financial planning services. Discount brokers often have user-friendly online trading platforms.

Client Base: Discount brokers attract self-directed investors who prefer to make their own investment decisions. They may also serve cost-conscious clients.

Fees: Their fees and commissions are lower compared to full-service brokers.

Examples: Charles Schwab, TD Ameritrade (now part of Charles Schwab), E*TRADE (now part of Morgan Stanley), and Fidelity.

3. Online Brokerage Firms

Description: Online brokerage firms operate exclusively through online trading platforms. They cater to self-directed investors who prefer to trade and manage their investments independently. These platforms provide tools, research, and resources for clients to make informed decisions.

Client Base: Online brokers are popular among individual investors who are comfortable managing their portfolios online and require minimal human interaction.

Fees: They offer competitive pricing, often with low trading commissions and fees.

Examples: Robinhood, Webull, Interactive Brokers, and Ally Invest.

4. Other Types of Brokerage Firms

In addition to the above three major types, various other types of brokerage firms also exist.       

a. Robo-Advisors

Description: Robo-advisors are digital platforms that use algorithms and automated processes to create and manage investment portfolios for clients. They typically offer a diversified portfolio of exchange-traded funds (ETFs) based on the client’s risk tolerance and financial goals. Some Robo-advisors also offer stock portfolios.

Client Base: Robo-advisors are suitable for investors who prefer a hands-off approach to investing and are looking for low-cost, automated portfolio management.

Fees: They charge management fees, often lower than traditional advisory fees.

Examples: Betterment, Wealthfront, and Vanguard Digital Advisor.

b. Institutional Brokerage Firms

Description: Institutional brokerage firms specialize in serving large institutions, such as pension funds, hedge funds, and mutual funds. They provide trading, research, and execution services tailored to the unique needs of institutional investors.

Client Base: Institutional brokers exclusively serve large organizations and professional investors.

Fees: Fees can vary based on the volume and complexity of transactions.

Examples: Goldman Sachs, Morgan Stanley, and J.P. Morgan.

c. Specialized Brokerage Firms

Description: Specialized brokerage firms are financial institutions that focus on specific niche markets or services within the broader financial industry. These firms primarily emphasize their expertise in a particular financial area, asset class, industries, or type of service.

Client Base: Specialized brokers cater to clients seeking expertise in a specific area.

Fees: Fees can vary widely based on the specific services provided.

Examples: Charles Schwab (it offers both full-service features and online trading platform), and Fidelity Investments (both financial advisors and online trading services are available).

d. Hybrid Brokerage Firms

Description: Hybrid brokerage firms combine elements of full-service and online brokerage models. They offer a blend of digital tools and human advisors to serve a broad range of clients.

Client Base: Hybrid brokers attract clients who value the convenience of online tools but also want access to human advisors when needed.

Fees: Fees can vary depending on the level of service clients require.

Examples: Thinkorswim (specializes in options trading), and Just2Trade (focuses on international trading).

e. Social Trading Platforms

Description: Social trading platforms allow users to interact, follow, and copy the trading strategies of experienced investors or traders. These platforms often integrate social networking features.

Client Base: Social trading platforms attract both beginners looking to learn from experts, as well as experienced traders who want to showcase their skills and build a following.

Fees: The fees on social trading platforms can vary, including charges for copying trades from experts or for providing your trading signals to others.

Examples: eToro and ZuluTrade.

What Is a Brokerage Account?

A brokerage account is an investment account held at a licensed brokerage firm, enabling individuals to buy and sell various types of securities, such as stocks, bonds, mutual funds, exchange-traded funds (ETFs), options, and futures.

The primary purpose of a brokerage account is to facilitate the trading of securities. Most brokerage accounts can be managed online or through mobile apps, offering convenience and real-time access to markets. To trade, investors must deposit funds into their brokerage accounts. They can link their bank accounts to transfer money in and out of the brokerage account as needed.

Brokerage Account Types

Brokerage accounts can be primarily classified into two main categories:

• Cash Account
• Margin Account

In a cash account, all trades must be fully paid for with the funds available in the account. This means you can only purchase investments with the money you have deposited in the account. You cannot borrow funds or securities from the brokerage to make trades. Since there is no borrowing, you won’t face margin calls.

In a margin account, you can borrow money from the brokerage to make trades. This borrowed money is referred to as margin. Margin accounts provide leverage, allowing you to control a larger position with a smaller amount of your own capital. For example, if you have $10,000 in your account, you might be able to buy up to $20,000 worth of securities (depending on the margin requirements and regulations). If the value of the securities in your account falls below a certain level (usually due to market fluctuations), you may receive a margin call. This means you must deposit additional funds or sell securities to cover the deficit.

Other types of brokerage accounts include:

• Full-Service Brokerage Accounts
• Discount Brokerage Accounts
• Online Brokerage Accounts
• Robo-Advisor Accounts
• Individual Retirement Accounts (IRAs)
• Corporate Brokerage Account
• Custodial Accounts

How do I pick a stock broker?

Choosing a stock broker is an important decision in your investing journey. The choice depends on your investment goals, trading style, and preferences. Here’s a step-by-step list to help you choose the right stockbroker for your needs:

1. Determine your Investment Goals

Identify your financial goals, such as retirement planning, wealth accumulation, or income generation. Assess your risk tolerance to determine your preferred investment approach.

2. Understand your Investment Style

Decide whether you want to actively trade stocks, invest in long-term assets, or both.

3. Research Different Types of Brokers

Explore the types of brokers available, such as full-service, discount, online, or robo-advisors.

4. Evaluate Brokerage Fees and Costs

Compare commission fees, account maintenance charges, and other costs associated with each broker.

5. Check Different Account Types

Determine whether you need a cash account, margin account, retirement account (e.g., IRA), or other specialized accounts.

6. Examine Available Services and Features

Review the range of services offered, including research tools, educational resources, and trading platforms.

7. Consider the Broker’s Reputation

Research the broker’s reputation, history, and any past regulatory issues. Look for online reviews and ask for recommendations from experienced investors.

8. Ensure Regulatory Compliance

Verify that the broker is registered with relevant regulatory authorities and adheres to industry regulations.

9. Test Customer Support

Contact the broker’s customer support to evaluate their responsiveness and helpfulness.

10. Assess Trading Tools and Platforms

If you plan to trade actively, test the broker’s trading platform for ease of use and reliability.

11. Check Account Minimums

Verify if the broker has a minimum deposit requirement to open an account.

12. Consider Mobile Accessibility

If you prefer mobile trading, check if the broker offers a user-friendly mobile app.

13. Analyze Fees for Extra Services

Some brokers charge extra for services like live data feeds or access to advanced tools.

14. Use Demo Accounts:

Some brokers offer demo accounts or trial periods. Use these to familiarize yourself with the broker’s platform and services.

15. Make a Decision

Based on your research, choose the broker that aligns with your investment goals, preferences, and budget.

What is a Broker-Dealer?

Stock brokers are known as broker-dealers when they perform both brokerage and dealer functions in the financial markets.

A broker is an intermediary who facilitates securities transactions on behalf of their clients. They don’t typically trade these securities for their own accounts. Instead, they act as an agent, executing trades according to their clients’ instructions. Brokers earn a commission or fee for their services.

A dealer, on the other hand, buys and sells securities for their own account. They often take on the role of market makers, providing liquidity to the markets by maintaining an inventory of securities. Dealers profit from the spread, which is the difference between the buying and selling prices of the securities they handle.

Broker-dealers, as the name suggests, combine both roles. They can execute securities transactions for clients as brokers and also trade securities for their own accounts as dealers. This dual role allows them to serve both retail clients and participate in trading activities that involve their own investments.

Broker-dealers are subject to specific regulations to ensure they handle these dual roles ethically and in compliance with financial regulations. In the United States, broker-dealers are registered with the U.S. Securities and Exchange Commission (SEC) and are regulated by the Financial Industry Regulatory Authority (FINRA). These regulatory bodies help ensure that broker-dealers operate within the boundaries of the law and maintain the necessary financial and operational standards.

How does a Broker make Money?

Brokerage firms make money through various revenue streams, which can include:

Commissions or Brokerages: Brokers earn a significant portion of their income from commissions. They charge clients a fee for each trade they execute on their behalf. This fee can be a flat rate or based on a percentage of the trade’s value. Commissions can vary depending on the type of security, trade volume, and the broker’s fee structure.

Brokers with zero commissions make money through various other revenue streams, such as Payment for Order Flow (PFOF), incentives for sweeping cash balances into a bank deposit account as part of a bank sweep program or into a money market mutual fund as part of a money market sweep program, premium services, robo-advisory or asset management services, and more.

Inactivity and Account Fees: Brokers may charge clients inactivity fees if they don’t make trades within a specified time frame. Account maintenance fees or other administrative charges can also contribute to a broker’s revenue.

Exchange Rebates: Brokers can receive rebates from stock exchanges for routing orders to those exchanges. “Brokers with the largest trading volume receive the largest rebates and thus pay the lowest net fees. Sometimes, large brokers get rebates that are even larger than the fees they paid – leading to a situation where the exchange actually pays on net large brokers for their order flow,” said SEC Chair Gary Gensler.

Payment for Order Flow (PFOF): Payment for order flow is a practice where stock brokers or brokerage firms receive compensation from market makers in return for directing their clients’ trade orders to those market makers. Market makers are willing to pay for order flow because it provides them with a steady stream of orders to execute.

Incentives for Sweeping Cash Balances: Many investors maintain uninvested cash balances in their brokerage accounts. In such cases, typical options for investors include leaving it in the brokerage account, sweeping it (automatically transferring it) to a bank deposit account as part of a bank sweep program, or sweeping it to a money market mutual fund as part of a money market sweep program. Many brokerage firms sweep such cash balances into banks affiliated with their parent companies. Others may sweep cash into partner banks and receive an incentive fee from them.

Premium Services including Research: Some brokers offer premium services, such as advanced trading tools, research reports, analysis, recommendations, robo-advisors, or enhanced customer support, for a fee. Customers willing to pay for these services can be another source of income.

Asset Management Services Fees: Brokers who are offering managed accounts or advisory services, charge management fees. These fees are typically calculated as a percentage of the assets under management (AUM). Investors pay a recurring fee for the broker’s ongoing management and advice.

Market-making Activities: Brokers acting as Broker-Dealers make money through their market-making activities by buying and selling securities on their own accounts. Market makers make a profit primarily through the bid-ask spread and trading volume.