A stock broker is specifically a broker that deals in stocks. For the purposes of this tutorial, we will use “stock broker” and “broker” interchangeably.
In a previous tutorial, we explained that buyers and sellers congregate in a “stock exchange” (aka “exchange”) to buy and sell stocks. Think of it as buyers and sellers congregating on eBay (the “exchange”).
The biggest stock exchange in the U.S. (and the world) is the New York Stock Exchange (NYSE)
A stock broker is a licensed individual or firm who executes buy and sell orders on behalf of clients. Nowadays, most brokers are online (e.g. online companies who buy and sell on your behalf). Think of your stock broker like a real estate agent. The agent buys and sells on your behalf.
This is what an investor/trader does:
- Select a broker (up to you, there are many brokers to choose from).
- Fund your brokerage account with cash $$.
- Buy and sell stocks through that broker.
- When you buy a stock, the broker deducts the cash price of the stocks you buy.
- The broker takes your order to the stock exchange (e.g. NYSE), which matches your buy order with someone else’s sell order. You have no idea who you bought the stock from. Could be someone halfway around the world.
- Once the order is fulfilled (within a few seconds), your brokerage account will reflect that you now own X shares of the company you bought, minus the amount of cash you spent on those shares.
- When you sell a stock, the broker takes your order to the stock exchange, which matches your sell order with someone else’s buy order. You have no idea who you sold the stock to. Could be someone halfway around the world.
- With the proceeds from the sale, your brokerage account will reflect the new cash from the sale.
Nowadays, these transactions all electronically (and automatically) occur within a matter of seconds.
Here’s an example.
- I open a brokerage account with Interactive Brokers (a specific U.S. broker).
- I fund the my stock brokerage account with $100k
- I log in to my online stock brokerage account, and place an electronic order to buy 200 shares of Apple at $100 a share.
- The brokerage deducts $20000 from my brokerage account to pay for the 200 shares. I now have $80k in cash in my account + $20k worth of stocks.
- The price of Apple then goes up to $120 a share.
- I want to sell all of my Apple stocks.
- I place an online order to sell my 200 shares of Apple through the stock broker for $120 a share.
- The broker conducts my transaction, and credits my brokerage account with $24k in cash (120 x 200 = $24k).
- My account now has $104k in cash ($80k cash from before + $24k in new cash).
Like a real estate agent, stock brokers usually take a fee for conducting your buy and sell transactions.
This fee can vary significantely. Many banks have their own stock brokers. These fees are usually quite high (>0.5% of the transaction’s value). Online brokers are much cheaper (often 0.01% of the transaction’s value).
How to select a stock broker
This is entirely up to you. Generally, you want to select and open a stock account with a broker that:
- Has low fees.
- Is big. Big brokers are safe.
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