Module I·Article III·~4 min read
Market Participants: Brokers, Dealers, Investors
Structure of Financial Markets and Infrastructure
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The Ecosystem of Financial Market Participants
The financial market functions thanks to the interaction of numerous participants with different roles, goals, and business models. Understanding the ecosystem of participants is necessary for effective navigation in the world of finance — both for the investor choosing intermediaries and for the professional working in the industry.
Brokers: Intermediaries Between the Market and the Investor
A broker is an intermediary who executes trades on behalf of and at the expense of the client. The broker does not take on market risk: they receive an order from the client, transmit it to the market, and receive a commission for the service. Legally, the broker acts as the client’s agent.
Full-service brokers provide a wide range of services: research, investment recommendations, portfolio management, access to IPOs. Full-service brokers' commissions are higher, but clients receive personalized service and expertise.
Discount brokers offer a minimal set of services at low prices — primarily order execution. The development of technology has led to the emergence of online brokers with commissions close to zero (Robinhood, Interactive Brokers, Tinkoff Investments).
Introducing brokers (IB) attract clients and transfer them to clearing brokers for actual execution and settlement. The IB model allows small firms to offer brokerage services without building expensive infrastructure.
Dealers: Trading for Their Own Account
A dealer is a market participant who trades for their own account and assumes market risk. The dealer purchases assets into ownership and sells them from their own portfolio. Legally, the dealer acts as principal.
The key difference between a dealer and a broker is the presence of their own position in the asset. The dealer earns on the spread between purchase and sale price, as well as on directional positions (betting on market movement).
A broker-dealer is a firm that combines both functions. Most large investment banks are broker-dealers: they can execute client orders as an agent and trade for their own account. Regulations require managing conflicts of interest between these functions.
Market Makers: Providers of Liquidity
A market maker is a dealer who has undertaken the obligation to continuously quote two-sided prices (bid and ask) for a specific instrument. Market makers provide market liquidity, allowing other participants to execute trades at any time.
The market maker’s business model is based on earning the bid-ask spread with a balanced flow of orders. Risk arises in case of imbalance — if the market maker is forced to accumulate a position in one direction, they are exposed to market risk (inventory risk).
Designated Market Makers (DMM) on the NYSE or specialists are market makers with formal obligations to maintain a fair and orderly market for the stocks assigned to them. They receive certain privileges (access to order flow) in exchange for liquidity obligations.
High-Frequency Trading (HFT)
High-frequency trading is algorithmic trading using ultra-fast technology to execute a large number of trades in fractions of a second. HFT firms often act as de facto market makers, providing a significant portion of liquidity on modern markets.
HFT strategies include: market making (earning the spread), statistical arbitrage (taking advantage of short-term price discrepancies), latency arbitrage (using speed advantage), event-driven strategies (reacting to news and data).
Critics of HFT point to potential risks for market stability (flash crashes), unfair advantage over ordinary investors, and “toxic” order flow for traditional market makers. Proponents note that HFT reduces spreads and increases pricing efficiency.
Institutional Investors
Institutional investors are organizations managing large pools of capital. These include: pension funds, insurance companies, investment funds (mutual funds, hedge funds), sovereign funds, university and charitable endowments.
Institutionals differ from retail investors by the scale of operations (millions and billions of dollars), long-term investment horizon, professional management, and regulatory requirements (fiduciary responsibility to beneficiaries).
When trading, large orders from institutionals create market impact — the very placement of an order influences the price. This necessitates the use of specialized execution algorithms (TWAP, VWAP, implementation shortfall), dark pools, and other mechanisms to minimize impact.
Retail Investors
Retail investors are individuals investing personal funds. Traditionally, retail comprised a small share of turnover, but the development of online brokers and mobile apps has led to significant growth in retail activity.
The “meme stock phenomenon” of 2021 (GameStop, AMC) demonstrated the new power of coordinated retail investors, capable of influencing prices even for large assets. This drew regulators' attention to gamification practices in broker apps and to the issue of payment for order flow.
Proprietary Trading
Proprietary trading (prop trading) is trading with the firm’s own capital for the purpose of generating profit. Unlike client business, prop trading is not related to servicing external investors.
After the 2008 financial crisis, prop trading regulation became stricter. The Volcker Rule in the United States limited the ability of banks to engage in proprietary trading, leading to the spin-off of many prop desks into independent firms.
Modern prop trading firms often specialize in HFT, quantitative strategies, or market making. They attract talented mathematicians, programmers, and traders, offering a share of profits.
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