What Does a Broker Do?
Brokers? Who needs 'em?
Well, you do. In order to buy shares of stock, you need a stockbroker to help you with the transaction. In the same way that CompUSA or Best Buy is the "middleman" between you and computer manufacturers, the broker (also called a stockbroker) is the link between you and the stock exchange.
To better understand what a broker is and how one operates, let's define the broker's role.
- A stockbroker is a salesperson.
- She works for a stock brokerage house (like Merrill Lynch or Charles Schwab).
- The broker's job is to carry out your transactions. (If you like Chinese food, the broker may also carry that out, but that's between the two of you.)
Common Questions About Stockbrokers
Q. How does a stockbroker get paid?
A. Brokers are paid by salary, commissions on sales, or a mix of both.
Q. What qualifies someone to become a stockbroker?
A. The glamorous life of stockbroker is not for everyone. Stockbrokers must pass two licensing examinations called the Series 7 and Series 63. Successfully completing these exams allows the broker to advise you, to solicit business from you, and to execute transactions on your behalf.
So: a broker is employed by a brokerage house to facilitate your transactions and, in the case of full-service brokers, to advise you in making your investment decisions.
Although a broker may do his own research, he is NOT a research analyst. He is not one of the people about whom you might read, "Sylvester J. Quibble of Hackensack Associates raised his estimate for Goosefeathers' fiscal year 1999 earnings from 19 to 35 cents per share, citing resurgence in demand for eiderdown quilts among bilingual tots." Research analysts are other folks who work for brokerages, and it is they who do that sort of enlightening, in-depth research of a company's business and industry.
Full-Service vs. Discount
The most important part of the process is determining what you need. Below is a general description of the services offered by full-service and discount brokers.
Full-Service. These brokers tend to offer a wider variety of financial products, as well as investment advice and research, than do discount brokers, and they charge considerably higher fees. They may offer stocks, bonds, derivatives, annuities, and insurance. A full-service broker solicits business and is paid mostly by commissions. This means that he is compensated not according to how well your portfolio does, but by how often you trade. This in turn means that it is in his interest to have you trade as often as possible - one of the main reasons why we at the Motley Fool eschew full-service brokers.
Discount. Discount brokerages do not offer any advice or research - they simply transact your trades with no frills. Because they manage fewer products than their full-service counterparts, discounters charge considerably lower fees. They also often offer online computer order entry services. Live brokers at these brokerages are usually paid a fixed salary to execute your trades. They don't solicit, and they aren't paid commissions. Discount brokerages make money by doing business in volume, competing mostly on price and "reliability" of the service: if they have the lowest prices and the best service, they get the most trades.
Online trading has exploded over the past year as investors are becoming more self-sufficient and comfortable using their computers for investing. That's great for all the technically inclined folks, but is it right for you? It's wonderful to be able to access your account information at a moment's notice and to place trades 24 hours a day. We like the idea of using an online brokerage account, but we also realize that some people prefer to deal with a real person when they are placing trades. Many discount brokers offer both options and, in general, the price of transacting a trade with a real live human being will be somewhat higher than if you conduct it on the Internet.
When shopping around for an online discount broker, you should ask plenty of questions about its customer service department. Sure, online brokerage accounts are becoming easier to use and are providing more and more information, but you need to know how you can access your account information if you can't get online for some reason and need to make a transaction. Will a "live" broker be accessible to you if you need to place a trade? What if you need a copy of your latest monthly statements for the IRS and the web site is down?
If you're comfortable with your computer and you don't really need to hear that voice on the other end of the phone, we recommend that you go with a discount broker and trade online. If you need to hear a voice, the solution is simple: Choose a discount broker that offers trading over the telephone.
Placing an Order
You've picked a broker, done your stock research, and you are ready to place an order. How do you do it? What types of orders can you place? In general, and in keeping with our overall long-term buy-and-hold philosophy, there are only two terms you need to know: "buy" and "sell." Sound simple enough? It is, and it really need not be any more complex than that. You buy a stock because you think it's a great long-term prospect, and you only sell it when you either need the money or feel that there's a better place to put that money.
That said, there are different types of orders. If only to let you know about them so that you're not bamboozled by the terminology when someone flings it at you, let's look at the major types of orders:
- Buy order. The order you place when, obviously enough, you want to buy shares. Simply tell the broker how many shares you want to purchase. There are several types of buy orders.
- Buy at market. You instruct the broker to buy a specified number of shares at the prevailing market price.
- Buy at a limit. You instruct the broker to buy a specified number of shares, but only at a specified price or lower. For example, you might say: "Buy 100 shares of Microsoft at a limit of $140." In this case, you are only willing to purchase shares of Microsoft if you can do so at $140 or less.
- Sell order. An order you place when you want to sell shares.
- Sell at market. An order to sell your shares at the prevailing market price.
- Sell at a limit. An order to sell your shares only at the price that you specify or higher.
- Sell at a stop limit. You instruct your broker to sell your stock if it falls to a certain price. For example, you buy Microsoft at $140 and you instruct your broker to sell if it falls to $130. This would be a Sell Stop at $130.