What a broker actually does with your money

A broker is the counterparty to your whole trading life, and most people choose one on the strength of the app and never think about it again. This piece covers what the business actually is.

Earlier pieces followed an order to a fill. This one is about the firm that carried it.

Agent, not shop

A broker does not usually sell you shares from its own inventory. It acts as your agent: it takes your instruction, routes it to a venue, and arranges the trade. For that it may charge a commission, and on US stocks many now charge none.

The firm also holds your assets. Cash sits in an account with the broker, and shares are held in street name, which means the broker is the registered holder and its records say the shares belong to you.

Where the money actually is

Uninvested cash is where the business model lives. A broker typically earns interest on client cash, and depending on the firm and the account, it may pass some of that on to you or none of it.

Client cash is required to be segregated from the firm's own operating money. That separation is the point: the firm may not fund its own business from client balances.

Cash accounts and margin accounts

In a cash account you trade with money you have. The main constraint is settlement: proceeds are not fully usable until the trade settles, and repeatedly spending unsettled cash triggers restrictions.

A margin account lets you borrow against your holdings. It changes the relationship materially. You are a borrower, the shares are collateral, and the agreement usually permits the broker to lend your shares to short sellers. If the value of the collateral falls far enough you receive a margin call, and if you do not meet it the broker may sell your positions, at its discretion, without waiting for you.

Borrowing magnifies outcomes in both directions and introduces the possibility of being forced out at the worst moment. Plenty of accounts are ruined by leverage rather than by bad analysis.

What protection exists, and what it is for

In the United States, most brokers are members of a scheme that protects customer assets if the broker fails and cannot return them, within published limits. Elsewhere, similar national schemes exist with different limits and terms.

The important part is the boundary. That protection covers the failure of the firm to return what is yours. It covers nothing at all about the value of what you hold. A share that falls ninety percent is not a covered event anywhere, and no scheme in any country insures against a bad trade.

Worth checking for your own broker: whether it is a member of a scheme, what the limits are, and whether the entity you opened the account with is the one covered.

What a margin call actually looks like

The phrase is familiar and the mechanics usually are not, which is a bad combination for something that can close your positions without asking.

A margin account has a maintenance requirement: a minimum proportion of the position value that must be your own money rather than borrowed. Regulators set a floor and brokers commonly set theirs higher, and a broker may raise its requirement on a specific volatile name at any time, including one you already hold.

If the value of your holdings falls far enough, your equity drops below that minimum and the broker issues a call for more cash or asks you to reduce the position. What happens next is the part worth understanding. The agreement generally allows the firm to liquidate positions at its discretion, without waiting for you, and to choose which ones. In a fast decline that can happen the same day.

The outcome is a forced sale at the worst available moment, decided by somebody else, in the position they choose rather than the one you would have chosen. It is the mechanism behind a large share of accounts that go from damaged to gone.

Dividends, corporate actions and the paperwork you never see

Because your shares are held in street name, anything the company does reaches you through the broker.

Dividends are credited by the broker once the company pays. Whether you qualify is decided by whether you held on the record date, which is why buying the day before a dividend does not entitle you to it. Stock splits are applied to your position automatically. Mergers, spin offs and rights issues arrive as corporate action notices, and some of those require you to make a choice by a deadline.

Voting works the same way. The broker holds the registered shares and passes a proxy instruction to you. Ignore it and your shares typically go unvoted, or in some cases are voted by the broker under rules that vary by matter.

None of this needs managing day to day. It needs knowing that a notice from your broker with a deadline is not marketing.

How brokers make money without commission

Interest on cash balances. Interest on margin lending. Fees for lending out shares. Payment for order flow, where a wholesale market maker pays for the right to execute retail orders. Premium subscriptions, data, and currency conversion on international trades.

None of that is hidden. US brokers publish their order routing and what they are paid for it. Reading that once for your own broker tells you more about your real costs than any general argument about the practice.

Best execution, and the report that proves it

A broker handling your order owes you a duty to seek the most favourable terms reasonably available under the circumstances. That is a duty of process rather than a guarantee of outcome: it does not promise the best price on every trade, it requires the firm to have a defensible method and to review it.

US brokers publish a quarterly report on order routing that names the venues they send orders to, the proportion sent to each, and the payment arrangements involved. Many also publish execution quality statistics: what share of orders received price improvement and how much per share.

Those documents are dull and they are the only hard evidence in an argument otherwise conducted with opinions. If you want to know whether your broker's routing costs you money, that is where the answer is.

Moving to another broker

You are not locked in. Accounts transfer between firms through an established process, usually initiated at the receiving broker, and positions generally move in kind rather than being sold, which avoids realising gains you did not intend to realise.

Three things commonly complicate it. Fractional shares usually cannot be transferred and are liquidated instead. The outgoing firm often charges a transfer fee. And the transfer takes days, during which the account is typically frozen.

Worth knowing before you need it, because the moment you most want to leave a broker is usually a moment when you also want to trade.

Outages, halts and the difference between them

A broker outage is your firm failing: the app will not load or orders will not send while the market is open. A trading halt is the exchange stopping trading in a company, for news or for a volatility trigger, and it affects everyone equally.

Brokers generally disclaim liability for losses during outages in the customer agreement, which is one reason to know whether your broker offers another route in, such as a phone desk or a web platform independent of the app.

Halts are normal market machinery rather than a fault. Trading pauses, orders queue, and when it resumes the price can reopen a long way from where it stopped. A stop order sitting through a halt behaves exactly as described earlier: it triggers on the reopen at whatever the book then offers.

The parts of the agreement worth reading

Nobody reads the whole customer agreement. Four clauses repay the effort.

• Margin and liquidation. Whether margin is enabled, and the firm's right to close positions without contacting you first.
• Securities lending. Whether your shares can be lent, and whether you receive any of the fee.
• Cash sweep. Where uninvested cash goes overnight and who earns the interest.
• Dispute resolution. Most US brokerage agreements require arbitration rather than court.

What to check before you fund an account

• Which regulator authorises the firm, and which protection scheme it belongs to.
• Whether your account is cash or margin, and whether share lending is enabled.
• What happens to uninvested cash and whether you receive any of the interest.
• The full fee schedule, including currency conversion and transfer out fees.
• How to move your account elsewhere, before you need to.

How the Den uses this

Nobody in the rooms recommends a broker, and that is deliberate. Broker choice depends on your country, your tax situation and what you trade, and a recommendation from a stranger on the internet is worth nothing against your own regulator.

What does come up constantly is the difference between a trading problem and a broker problem. A fill far from the expected price is usually an order type problem. A position closed without warning is usually a margin problem. A missing dividend is usually a settlement date problem. Those are three different conversations, and knowing which one you are in saves a great deal of frustration.

The other habit worth taking: know whether you are on margin before you find out the hard way. Many accounts are opened with margin enabled by default, and the first time some people learn this is when a position is liquidated on their behalf.