Many people new to the financial markets come across the terms market maker, dealer, and broker. Can these terms be used interchangeably? If not, what are the differences and the attributes needed to succeed in each of the roles?
The exact definition may depend on the company you work for or the region you are in to confuse things a little. US definitions differ a little from the UK, for example. Below we describe in general what these terms mean.
A broker is a person who buys or sells assets for other people. A real estate agent as a broker for properties, for example.
In financial markets, a broker will send a client order to a market where it can be executed or finding the other party to the trade directly. A broker has little discretion in making decisions as their trades are mainly governed by the instructions they receive from clients.
A broker generally never buys or sells assets for themselves. They are instead the person bringing the buyer and seller together. For large deals, a broker may call several clients to find the other side of the trade. They may also split the order between clients and the exchange for assets such as equities. Brokers often provide value-added services to their clients, like data/research service and margin management services for derivatives.
A broker earns a commission from their clients, meaning the larger the trade value, the higher the compensation they receive.
Brokers have excellent communication, negotiation, and influencing skills and possess an in-depth understanding of their clients' needs objectives. They can successfully manage multiple work streams at once. This requires attention to detail and strong decision-making abilities. A broker must give their clients assurance that they will always act with integrity and honesty, putting their interests before themselves.
A financial markets dealer is an individual or financial institution willing to buy a security from a client at a quoted bid price or sell a security to a client at an ask, or offer, price. The terms "principal" and "dealer" can be used interchangeably. This means while a broker facilitates for clients, a dealer facilitates trades on behalf of itself.
A dealer earns their profit from the spread between the bid and asks the price. This bid-ask spread will be small for highly liquid markets such as the currency markets but more comprehensive for less liquid markets, such as credit derivatives.
Technology has impacted financial markets in recent years, with dealers being significantly affected. Increased technology requirements, industry consolidation, and the heightened regulatory environment have increased costs and squeezed profits. Some of these technology changes are discussed in Fmi's Global Markets pathway.
Dealers need many of the same skills and attributes as brokers. Being a successful broker is all about building and maintaining relationships with clients, so exceptional interpersonal and networking skills are needed. Many IDBs also look for people with a second language, and for electronic inter-broking, it is critical people are comfortable with technology.
“What is a market maker?”. Market makers are very similar to dealers because they make money from quoting a bid and an offer and are typically large banks or financial institutions. While dealers usually operate in Over-the-Counter or OTC markets, a market maker generally stands in an exchange, a place where everyone trades against everyone. Being associated with an exchange means a market maker has more requirements to fulfil than a dealer. For example, the exchange may require a market maker to manage opening auctions, meet exchange depth and liquidity requirements, and keep their quotes in line with electronic trading.
A well-known example of market makers, or market-making is Designated Market Makers, or DMMs, that stand on the New York Stock Exchange or NYSE. As a DMM, firms must continuously provide a bid and an offer for stocks that trade on the exchange, usually for specific securities. In this way, market makers ensure there's enough liquidity in the markets. Liquidity means there is enough volume of trading so trading can be done seamlessly.
If you are wondering “how to become a market maker?” then keep in mind that market making is very technology-driven. People working within these firms often require technology and highly developed quantitative skills. It is a faced and ever-changing environment, being heavily influenced by market conditions, so a level of adaptability and resilience will help people succeed.
Finally, Inter-dealer brokers or IDBs, are specialist firms that work within the over-the-counter derivatives and bond markets as intermediaries between traders at investment banks and other trading houses. IDBs operate in markets that do not have a market maker - a securities or assets dealer in securities who only buys or sells at specific prices. Fmi's Global Markets pathway has an entire chapter on IBDs and how they execute trades for clients.