Trading and Exchanges Chapter 7: What Brokers Actually Do For You (Part 1)
You open Robinhood, tap “Buy,” and 0.3 seconds later you own shares of Apple. Simple, right? But between your thumb tap and that trade actually happening, there is a whole chain of people and systems doing work for you. Chapter 7 is about those people. Brokers.
Brokers Are Not Dealers
First thing Harris clarifies: brokers and dealers are not the same thing. A dealer trades with you. A broker trades for you. They find someone else to take the other side of your trade and charge a commission for the matchmaking.
Many brokers also give investment advice, which means they influence what you trade. Whether that is helpful or harmful depends on the broker. We will get to the ugly parts in Part 2.
Why Do Brokers Even Exist?
You might think: why do I need a middleman? I can just trade directly. Well, Harris gives five solid reasons why brokers earn their keep:
Clearing and settlement. The boring but critical one. When you trade, you need to make sure the other person actually pays up. Without brokers, every trader would need to check the credit of every other trader. Harris does the math: 1 million traders with no brokers means nearly 1 trillion potential credit relationships. Add 100 brokers serving 10,000 clients each, and that drops to about 2 million. A 500,000x reduction. Brokers let strangers trade with strangers.
Access to exchanges. Most exchanges only let members trade. If you are not a member, you need a broker who is. Even today, your app’s broker is the member who sends your order to the exchange.
Access to dealers. Setting up credit and settlement relationships is expensive for small, infrequent trades. Your broker already has those relationships, so you get access through them.
Trading expertise. Good brokers know who wants to trade what, and at what price. Block brokers who handle huge institutional orders are especially skilled. Harris compares them to poker players. Floor traders used to watch brokers for nervous body language that might hint at large orders. The best brokers gave nothing away.
Order representation. You have a life. You cannot watch the market all day. So you give your broker a limit order or stop order, and they watch the market for you. When conditions are right, they execute.
The Brokerage Firm: Front, Back, and Proprietary
Harris walks through how a brokerage firm is organized. Think of it in three layers:
Front office is everything client-facing. Sales brokers, floor brokers, financial analysts, customer service.
Back office is the infrastructure. Accounting, clearing, settlement, compliance, credit management. Fun historical detail: in 1968, U.S. equity volume grew so fast that firms could not keep up with paperwork. Exchanges closed on Wednesdays for six months so back offices could catch up. That forced the industry to automate.
Proprietary operations include the firm’s own trading and any speculative trading for its own account.
Full Service vs. Discount Brokers
Commission structures tell you a lot about what you are actually buying. Harris lays out the spectrum:
Full-service brokers charge the most but give you research, advice, and personal attention. Many use “wrap accounts” with a flat fee (1-3% of portfolio value) covering everything. This reduces the incentive to churn your account, which is when a broker recommends trades mainly to generate commissions.
Discount brokers give you cheaper execution with less hand-holding. Deep discount brokers provide almost no service beyond executing your order.
Robinhood, Webull, and other zero-commission apps are the extreme version of the discount model. They charge nothing in commissions but make money other ways.
How Brokers Actually Make Money
Commissions are the obvious revenue source, but Harris lists several others that explain how discount and zero-commission brokers survive:
Payment for order flow. Dealers pay brokers to send them your orders. Harris notes that in 1997, this was 24% of E*TRADE’s transaction revenue. This is exactly the business model that Robinhood later made famous (and controversial).
Interest on cash balances. That cash sitting in your brokerage account? Your broker invests it and earns interest. They pay you little or nothing on small balances and pocket the difference.
Margin loan interest. When you borrow to trade on margin, your broker charges you interest. Rates are typically a couple of points above the broker call money rate.
Short interest rebate. When you sell short, your broker lends out securities and collects interest on the cash collateral. For retail clients, the broker usually keeps all of this.
Soft dollars. This one is wild. Institutional clients pay higher commissions in exchange for “free” research. The system exists because funds prefer to hide costs inside commissions rather than report them as explicit expenses. Harris estimates soft dollar research exceeded $1 billion by 1998. Congress literally protects this with a safe harbor provision from 1975.
The Takeaway So Far
Brokers exist because trading is more complicated than it looks. They solve trust problems, provide access, offer expertise, and manage the plumbing. Even your “free” trading app is a broker making money off your order flow and idle cash.
But here is the thing Harris keeps hinting at: brokers are agents, and agents do not always act in your best interest. Part 2 covers the principal-agent problem, dishonest broker practices, and how to protect yourself.
Previous: Chapter 6: Order-driven Markets