There are different players in the financial market, these players play different important roles in the market. Two key players amongst others are the brokers and market makers. These two parties are interdependent on one another. They both collaborate to ensure efficiency in the market and they ensure the market is liquid for traders. For instance, brokers serve as an intermediary between forex traders and the liquidity providers, they facilitate a seamless trade by executing trades for traders, while market makers provide tradable currency pairs and pricing information for other stakeholders in the forex market.
In this publication, we are going to delve into the relationship between brokers and market makers to understand their relationship. We'll explain who brokers and market makers are, their roles in the financial market, and the symbiotic relationship between them. By the end of this blog post, you will understand the key aspects of the relationship between these two parties. Sit tight and enjoy.
Brokers: The Middlemen
Let's start by pointing out that brokers are regulated and licensed bodies. These bodies are intermediaries who are authorized to purchase securities on behalf of an investor. Before any firm is considered to be a broker the firm must have the expertise to operate in the financial market.
Brokers offer investors investments in financial securities, real estate, mutual funds, stocks, and exchange-traded funds (ETFs).
Brokers in the United States of America must be registered with the Financial Industry Regulatory Authority (FINRA) and they are obliged to act in the best interest of their clients.
The emergence of online trading platforms has brought about the rise of online brokerage platforms, this has led to a positive impact on trading as traders can seamlessly initiate transactions with little to zero contact with their broker.
We have the full-service vs. discount brokers, and the retail vs. institutional brokers. We will briefly explain the most common types which are the:
- Full-service brokers.
- Discount brokers.
Full-service brokers
Full-service brokers offer their clients more value-added services. They offer consulting, investment advice, research, and retirement planning. Investors pay higher commissions for their trades due to the value-added services.
Full-service brokers provide trading platforms, hedging solutions, customized speculative, trade execution services, and options contracts. The use of options gives investors the right to buy or sell securities at a current price when the contract expires in future. Brokers get commissions based on their client's trading volume and the amount of new accounts brought in in this type of brokerage.
Discount brokers
Discount brokers let investors trade at a lower cost, however, investors don't receive the personalized investment advice that full-service brokers offer. The lower fees are based on trading volume. This type of broker doesn't get a commission or give their employees a commission, they are only compensated with their salary.
Market Makers: Providers of Liquidity
Market makers could be individuals or firms. Market makers continuously quote two-sided markets in specific financial security by the provision of offers or asks and bids along with their market size. Market makers are liquidity providers, they ensure there is liquidity and depth in the market and they make a profit from the difference in the bid-ask spread. Sometimes and if they want they can make principal trades— trades from their accounts. Market makers make selling and buying possible, for example, if you want to sell a bond they purchase the bond. Likewise, if you want to buy a stock they ensure the stock is available for you. There are different examples between brokers and liquidity providers. Some examples of market makers are Morgan Stanley, UBS, and BNB Paribas.
Market makers profit from the spreads between the price investors get and the market prices. They also make a profit from the commission received by liquidity provided to their firms.
The Symbiotic Relationship
As we stated earlier, the relationship between these parties is symbiotic. Starting with the broker, a broker relies on market makers to make money. Brokers need efficient order execution, especially for less liquid securities. This is where market makers come in. The market makers need to generate order flow, and increase trading activity and their potential profit. This is where brokers come in.
For easier understanding, market makers provide liquidity for brokers. When a trader places an order with the broker, brokers contact market makers to execute the trade. Once contacted the market makers analyze the order and the market conditions. If profitable the market maker agrees to buy or sell the asset as a counterparty. Once this is established, the broker charges the trader a commission on the trade while the market maker earns profits if they purchase or sell assets at profitable prices.
Final Thoughts
When brokers and market makers efficiently play their roles the market will run smoothly. Trading and other market activities would not be very different from what we know if these parties did not have the relationship they have. It is good for all stakeholders to understand the role of these parties and a better understanding of these financial cogs will improve your decision-making process in the market.
