How brokerage firms make money?

Question

I havea question about how brokerage firm makes money. Me and my friend had a arguement about it. The question is this. When traders bid for a stock at a certain price and someone asks for that stock at the same price then the trade gets executed right? But then he says when a bidder bids for a stock like google at 417.50 and the ask is 417.50, the brokerage firm will try to wait and get the stock at 417.40 or lower and then off that lower amount is what they profit or the spread. is this true? if so is this still legal?

Answer 1

None of these answers make any sense. Brokerage firms (the big ones) make the majority of their money on banking/underwriting/management fees, and prop trading. The traditional trading desks at most firms at loss leaders. There are no market makers in the crowd on the floor of the NSYE. The market maker would be the specialist, and he is responsible for keeping the book and matching off buyers and sellers - not the brokers in the crowd, who are there simply to enter buy and sell orders on behalf of their customers.
In your example if GOOG is 417.50 bid offered at 417.75 and sombody HITS the bid at 417.50, the trade gets executed. If somebody TAKES or LIFTS the offer at 417.75 the trade gets exectuted. If a market maker has an order to buy stock at 417.50 he is obligated to reflect that order in his quote and buy the stock for the customer, not the firm. He has the option of improving the price on the buyside, in this example lets say 417.60, and he can buy that stock for his own account and 'trade ahead' of the customer. He can then offer the stock at 417.75 for his own account and hope sombody takes them. He would then make .15 on the stock.
Another option would be to sell the stock at .50 to the customer, hope the stock goes lower, and buy them back at .40 (or lower) and make a dime (or more). This practice has is not really as prevelant as it used to be, because decimal pricing has narrowed spreads dramatically.
BTW - The published bid and the offer (or ask) will never be the same. This is known as a locked market (crossed market if the offer is actually lower than the bid) and it is illegal.

Answer 2

I'm a retired stock broker so I can help answer this. Brokerage firms make their money mainly through commissions. For example, when a stock is bought or sold, the brokerage firm earns a commission... usually a minimum of $50 for a full-service firm. Some online brokerages might charge a commission of $7 for the very same trade... but they offer no advice or guidance. For mutual funds, brokerages will sell what is called a load fund... an upfront sale charge for buying the shares; also, as long as the client holds the fund, the broker will earn what is called a trail (a small percentage each month based on the number of shares or the value of the fund). Brokers also earn commissions on bonds called points... if a bond sells for two points, the broker has earned $20. Doesn't sound like much for the bonds, but if the broker sells 100 of them he has earned himself $2,000 in commissions. Brokers offer guidance to clients and share researched stocks and other investments with them; that's what you're paying commissions for: advice from the experts. Unfortunately, the experts aren't always right... but they certainly outperform the novices... and that's why despite all the cheaper online services, brokers at full-service firms continue to thrive.

Answer 3

If you get a lower fill, you're supposed to get the lower fill price. Whether that always happens or not is a different story.

In your example, the brokerage firm should only make money off of the spread IF the market maker on the floor is working for that firm.

Within each pit, there are usually multiple market makers. Each market maker works for a firm. Those firms reaps the "rewards" of what the market maker generates in spread and in handling volume.


That said, brokerage firms make money by charging commissions and taking a cut of it. Now of the commissions, some of it gets paid out to the exchanges and various other parties. In some of these cases, the firm also gets a little "kickback" of part of the fees that they have to pay to someone on your behalf, but that amount is already included in the commission that you pay.


Brokerages also make money in many other ways.

They make money by managing your money and taking a cut for doing that.

They make money by holding your money and keeping a % of the interest that accrues.

They make money if they have any mutual funds as each fund generates millions to billions in "management" fees.

They make money on just about everything you do related to investing.

Hope that helps!

Answer 4

You're right-brokerage firms do profit off of the spread, and it is legal. They also profit by charging commissions for every trade, management fees, and various underwriting issues. All in all, not a bad industry to own.