How Do Brokerage Firms Work?

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If you have ever invested in a 401(k), Roth IRA, traditional IRA or even opened an account with services such as Robinhood or Webull, you have likely participated in the stock market and have done business with a brokerage firm. There are many different types of investment accounts that rely on brokerage firms for management. These firms can help you execute trades and even assist you in making wise investment choices.


Brief History

In 1790, the United States' first stock exchange was founded in New York City. Originally stock exchanges involved mainly transactions between banks and companies; the companies sold stocks to raise capital from the banks without having the hassle of obtaining a loan. By the 1820s, individuals had begun investing in stocks, and companies also began trading with one another.

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Stockbrokers and brokerages firms were formed as a way to professionally mediate these transactions. Today, the law requires that all stock transactions be conducted with the help of a registered brokerage firm or independent stockbroker. This means that individual investors cannot simply buy stock without the help of one of these professionals. Though it adds an extra step and expense to investing, it helps to protect all parties involved.


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Brokerage Firms and the Trade of Stocks

Traditionally, brokerage firms have made the majority of their profits by brokering stock trades. The firms act as their clients' legal representatives on the floor of the stock exchange.

The brokerage firm's client informs the firm which stocks it would like to buy or sell, how many stocks and at what price. The brokerage firm then sends a stockbroker to the floor of the stock exchange where he performs these duties on behalf of the client. The brokerage firm receives a percentage from this sale as its fee. If the transaction loses the client money, the brokerage firm also loses money.


Brokerage firms can also perform stock transactions as the principle, buying or selling stocks for their own firm. In this case, the company decides which stocks it would like to invest in and sends a broker to the exchange floor to perform the same transaction as he would for a client.

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Brokerage Firms as Investment Advisors

According to Investopedia, some of the best stock websites and brokerage firms can also act as financial and investment advisors. In this role, the firm studies the client's immediate financial needs and long-term financial goals. The firm devises a plan of action, advising the client on which stocks that he should buy or sell. The brokerage firm leaves the final choice up to the client. For this service, clients are usually charged a fee.


Brokerage Firms as Client Representatives

Kaplan reports that if a client wishes to leave his stock transaction decisions up to his brokerage firm, he can authorize the firm to act as his legal representative. The brokerage firm then performs a combination of investment advising and brokering by deciding what transaction would be in the client's best interest and performing the stock transaction. Brokerage firms can charge clients a fee for this service or take a percentage of the transaction profits.