What is a broker, what do they do and what are the differences?


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What is a broker, what do they do, what different brokers are there and how does a broker make money? In this blogpost I answer all of your questions about brokers but were afraid to ask.

What is a broker?

A broker is the link between your money and the market. This can be an intermediary or a company. As a trader or investor you send your buy and sell orders to the broker, who then executes them for a fee.

Nowadays, almost all orders are executed digitally and in a variety of markets and instruments such as

  • Stocks
  • Currencies (Forex)
  • Crypto
  • Investment funds
  • ETFs
  • Indices
  • Commodities

Some brokers specialize in a certain market and others offer access to almost all markets.

Broker definition

Fun fact for the nerds: the meaning of the word broker comes from the French word broceur, which means little trader. That word probably comes from brocheor , which means wine merchant.

Source: Wikipedia

What does a broker do?

A broker mediates in buying and selling. Just like a real estate agent with a house. For this, the intermediary or company receives a fee in the form of a commission.

Brokers can also act as a dealer, in which case they buy and sell from their own inventory. Usually they don’t charge a commission for this, but a surcharge.

This video briefly explains what a broker does:

What types of brokers are there?

There are different types of brokers. In this section I show the differences including some pros and cons.

Full service brokers

Also know as asset managers. These are individuals or companies that manage money on behalf of their clients with the goal of making that money grow.

A risk analysis and capital objective are determined in consultation with the client. The client’s money is invested based on the outcome of this assessment. For example in shares, bonds and real estate.

Pros:

  • Personal contact
  • Have large amounts managed
  • Let professionals work for you

Cons:

  • High management costs
  • Large starting capital needed
  • Not being able to trade actively

Your own bank

You can also invest through your own bank. All banks can act as a broker between your money and the stock exchange. Investing and trading through your bank generally has the same advantages and disadvantages as using an asset manager.

Pros:

  • Personal contact
  • Trust from your own bank
  • Let professionals work for you

Cons:

  • Higher management costs
  • Limited options
  • Not being able to trade actively

Forex brokers

Forex brokers focus on the foreign exchange market. Forex traders are active investors who often keep their positions open for the short term. Large institutions such as banks are active in this market, but also retail traders who buy and sell currencies as a hobby or for a full-time income. With the goal of course to make a profit.

What is a broker without currency?
What is a broker without currency?

Active Forex traders use online Forex brokers. You submit your orders yourself via an online trading platform and the Forex broker executes these orders for you.

There are 3 different types of Forex brokers:

  • No Dealing Desk
  • Market Maker
  • Electronic Communications Network

The difference between these variants is in the execution of the orders.

No Dealing Desk or NDD

These brokers collect the best prices from different liquidity providers and fill the orders of their customers at the best price.

Market Maker

Market Makers trade against their customers and therefore take a position on the other side of your trade. This lowers the costs because they also earn from the losing trades of their customers.

ECN brokers

These brokers match trades from different traders with each other. This is this actually the most “fair” variant among the Forex brokers.

Pros:

  • Access to the highly liquid Forex market
  • 24-hour market, so a big window to make your trades
  • Allows for active trading
  • Use a leverage

Cons:

  • Access to only 1 market
  • Many unreliable providers (bucket shops)

If you’re looking for a reliable Forex broker, check out:

Get your free Pepperstone demo account…

71,4% of retail CFD accounts lose money

Online brokers

These are online platforms where you as a trader or investor have access to different markets. Some big players are Interactive Brokers and Think Or Swim. These brokers are often a lot cheaper than investing with your own bank and also offer opportunities for active traders.

Pros:

  • More affordable than trading with your own bank
  • Wide range of assets
  • Attractive for active traders

Cons:

  • No personal contact or investment advice
  • For currency trading often higher costs than with a true Forex broker

Copy trading brokers

Brokers that offer copy trading are a bit of a novelty, since it is a fairly new way of trading. eToro is a good example of this. With this broker you have the option to (automatically) copy successful traders and investors. This is also called social trading.

You can also trade with this broker yourself and get access to almost all markets.

Get your free eToro demo account…

75% of retail CFD accounts lose money

CFD brokers

You can also trade online through a CFD broker, but with the big difference being that you don’t actually purchase the stocks or other assets. Instead, you bet on price increases and decreases (going short) by means of a contract. Also called Contract For Difference (CFD for short).

Benefits:

  • Very low costs
  • Access to almost all markets (including crypto)
  • Intended for active traders
  • Easy to understand
  • Take larger positions with leverage
  • Practice on a demo account

Cons:

  • Not suitable for long-term investing because of overnight fees
  • Leverage can be dangerous with poor risk management

What is a reliable broker?

As with all markets where a lot of money is involved, there are also brokers who don’t have the best intentions with their traders and investors. These brokers are also called “bucket shops”. Unreliable brokers who’s sole purpose is to get as much money out of your pocket as possible.

Below are some tips for finding a reliable broker:

  • Check how and where they are regulated
  • Regulation within the European Union is the best
  • Check the contact details
  • Test customer service and accessibility
  • Find out how long they have been around
  • Make test small deposit and withdrawal before funding account

How does a broker make money?

Brokers earn money by charging costs for transactions, interest, custody fees and sometimes also for managing your account.

You pay the costs for transactions through commissions (fixed amount per trade) or spreads (difference between bid and ask). These costs can vary per market, asset or volatility. For example, if the price moves strongly a broker may decide to widen spreads.

Which broker should you choose?

I think you can feel this one coming… it all depends on your preferences, such as:

  • Do you want to invest yourself or have it managed?
  • Are you an active trader or long-term investor?
  • Do you want access to 1 market or more?
  • Do you want to own the asset and underlying value?
  • Do you want to use leverage?

I trade with CFD brokers because I am an active trader. I want to have access to all markets and want to use leverage.

What is a broker without a demo account?

If you are just starting out I recommend that you start with a CFD broker. There you can also create a demo account to practice with play money.

This is a nice way to find out if a certain market suits you. If you want to specialize, you can of course always choose another broker, but you can also switch to real money with your CFD broker.

By clicking the link below you can easily create a demo account and practice with $10,000.

Get your free BDSwiss demo account…

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If you have any questions about brokers, feel free to ask them in the comments below. And don’t forget to share this post.

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