What Is a Dealer?
Let me start by defining what a dealer is in the trading world. Dealers are individuals or firms that buy and sell securities for their own account, often through a broker or directly. You should know that a dealer acts as a principal in these trades, meaning they're trading on their own behalf, unlike a broker who just executes orders for clients.
Dealers play a crucial role in the market. They make markets in securities, underwrite them, and offer investment services to investors like you. When you check the price of a security in the over-the-counter market, the bid and ask quotes you see come from these dealers. They create liquidity and support long-term market growth. In the U.S., dealers are a distinct category, but in Canada, the term 'dealer' often shortens to 'investment dealer,' which is similar to a U.S. broker-dealer.
Understanding Dealers
To understand dealers better, consider that they stand ready to buy securities at their bid price or sell at their ask price from their own inventory. Their goal is to profit from the spread between those prices while adding liquidity to the market. They don't act on behalf of clients or facilitate deals between others; that's not their role.
Remember, a dealer differs from a trader. A dealer conducts this as regular business, whereas a trader might buy and sell for personal reasons, not as a business. In recent years, dealers have faced challenges like advanced technology demands, industry consolidation, and stricter regulations that raise compliance costs.
Regulating Dealers
Dealers are regulated by the Securities and Exchange Commission (SEC). If you're involved in trading, you need to know that all dealers must register with the SEC and join the Financial Industry Regulatory Authority (FINRA). This applies to anyone who markets themselves as willing to buy and sell a specific security continuously, runs a matched book of repurchase agreements, or issues and trades securities they originate.
Under SEC rules, dealers have specific duties: execute orders promptly, disclose material information and conflicts, and charge reasonable prices based on the market. They can't start business without SEC approval, must join a self-regulatory organization, become a member of the Securities Investor Protection Corporation, and meet state requirements.
Dealers vs. Brokers
Let's clarify the difference between dealers and brokers, as they both deal with securities but in distinct ways. A broker facilitates transactions by connecting buyers and sellers, charging a commission for the service. In contrast, a dealer trades from their own portfolio, charging a markup on sales since they're the principal in the trade.
Many firms act as both, known as broker-dealers, ranging from small independents to arms of major banks. Dealers aren't held to the fiduciary standard like registered investment advisors, who must prioritize client interests above their own.
Dealer Markets
In a dealer market, multiple dealers gather to buy and sell securities using their own accounts. This setup allows them to deal directly with each other, closing transactions with their funds, unlike broker markets where agents represent buyers and sellers. Brokers can't trade in dealer markets, and dealers set all terms, including the price.
Other Dealers in the Market
The term 'dealer' isn't limited to securities. It applies to anyone trading specific products or services, like a car dealer selling automobiles or an antique dealer handling collectibles. But in this context, we're focusing on securities dealers.
Dealer FAQs
You might have questions about dealers, so let's address some common ones directly.
How Do Dealers Make Profits in a Dealer Market?
- Dealers profit by buying securities at the bid price and selling at a higher ask price; the spread between them is their profit.
How Do You Open an Account With a Broker-Dealer?
- To open an account, provide personal details like name, Social Security number, address, and financial info; check the broker's background via the SEC, choose between cash or margin accounts, and decide on investment authority.
What Companies Are Dealers?
- Over 3,400 securities firms exist per FINRA, with major ones like Fidelity Investments, Charles Schwab, and Edward Jones.
What Companies Are Broker-Dealers?
- Broker-dealers can be individuals or firms, with more than 3,400 options according to FINRA.
The Bottom Line
In summary, dealers buy and sell securities for their own accounts, regulated by the SEC, and are vital for making markets, underwriting, and serving investors. They differ from brokers and operate in specific market environments to ensure liquidity and growth.
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