What is the difference between dealers and brokers?

Dealers are market participants who actively buy and sell securities and other financial
instruments for their own account. Dealers often act as a market maker. This means they actively
quote bid (buy) and ask (sell) prices for specific securities or financial instruments. By
continuously providing these prices, dealers create liquidity in the market, making it easier for
buyers and sellers to trade. Dealers facilitate transaction by maintaining an inventory or stock of
securities or financial instruments they trade. This inventory allows them to quickly buy or sell
when there is demand in the market. The size and composition of the inventory depend on the
specific strategies and focus of the dealer. Unlike brokers, dealers aim to profit from the
difference between the buying and selling prices, known as the spread. They buy securities at a
lower price (bid) and sell them at a higher price (ask), capturing the spread as their profit. This
spread compensates dealers for the risks they assume and the services they provide. Dealers
interact with various market participants, including institutional investors (such as pension funds,
mutual funds, and hedge funds), retail investors, other dealers, and even other financial
institutions. They play a crucial role in providing liquidity to these participants, allowing them to
buy or sell securities without significant price disruptions. They operate in different financial
markets, such as equity markets, bond markets, foreign exchange markets, and over-the-counter
(OTC) markets. Let's consider Investment Bank X. The trading division of Investment Bank X
engages in market-making activities, actively buying and selling securities for its own account.
For instance, in the bond market, Investment Bank X's traders actively quote bid and ask prices
for specific bonds and maintain an inventory of bonds. They facilitate trading by providing
liquidity and are willing to buy or sell bonds to other market participants at the quoted prices. In
this case, Investment Bank X's trading division acts as a dealer, trading securities for its own
account.
Brokers act as intermediaries between buyers and sellers in financial transactions.
Brokers do not engage in buying or selling securities for their own account. Instead, they work
on behalf of individuals, institutional investors, or corporations to execute trades and investments
according to their client’s instructions and objectives. When clients want to buy or sell securities,
they communicate their orders to the broker, who then seeks to execute those orders at the best
possible price and terms. Brokers have access to market data, trading platforms, and networks
that enable them to find liquidity and execute trades efficiently. They also possess an in-depth
knowledge of financial markets, including securities, market trends, and investment strategies.
They provide valuable market insights and research to their clients, helping them make informed
investment decisions. Brokers stay updated on market developments, economic news, and
regulatory changes that could impact their clients’ investments. They also handle the process of
order routing, which involves transmitting clients’ orders to the relevant market or exchange.
They consider factors such as price, liquidity, speed, and regulatory requirements when routing
orders. Brokers aim to find the best execution for their clients, seeking the most favorable prices
and minimizing transaction costs. Brokers earn commission or fee for their service. The fees can
be based on a percentage of the transaction value, a fixed fee per trade, or a combination of both.
Brokers operate in various financial markets such as stocks, bonds commodities, and foreign
exchange. For example, Investment banks often have brokerage divisions that offer brokerage
services to their clients.
For instance, let's again consider Investment Bank X. The brokerage division of Investment
Bank X receives orders from clients to buy or sell stocks. The brokerage team, acting as brokers,
identifies the best available prices in the stock market and executes the trades on behalf of their
clients. They charge a commission or fee for their services. In this case, Investment Bank X's
brokerage division acts as a broker, facilitating trades between clients and the stock market.
In summary, the main differences between dealers and brokers are:
1) Role: While dealers represent themselves and their own interest by buying and selling
securities for their own account, aiming to profit from price differentials and represent
their own interest. Brokers represent their interest of their client by acting as
intermediaries and facilitate trades on behalf of their clients
2) Profit: While dealers generate profits from the spread between buying and selling prices.
Brokers earn commissions or fees for executing trades on behalf of clients.
3) Risk and Inventory: While dealers assume market risk by maintaining an inventory of
securities and trading for their own account. Brokers who do not hold inventory do not
carry market risk as they execute trades on behalf of clients.
4) Market Making: While dealers often act as market makers by providing bid and ask
prices, ensuring market liquidity. Brokers do not typically serve as market makers.
5) Regulatory Focus: While dealers are subject to regulations related to securities trading,
market making, and risk management. Brokers are regulated as intermediaries and must
comply with rules governing client representation, order execution, and client protection.
 References

Adam Hayes. (2023). Dealer. Investopedia.

Arielle O’shea. (2023). What is a broker? Nerdwallet.

Chara Yadav. (2023). Broker vs Dealer: Difference and Comparison.

Charm. (2010). Difference between broker and dealer.

Corprate Finance Institute. (N.A.). Dealer Market.

Tim Smith. (2023). Broker. Investopedia.