In the first of a new series about the financial markets, Kevin Morgan, of OMF, explains what a broker does and how investors use a broker.
In this world of international trade, there are financial markets all round the world.
You can’t trade yourself on markets in New York, London or Sydney, so you need a broker to physically connect you with global markets.
You can buy and sell on an online platform, but your platform is an electronic broker instead.
What does a broker do?
A broker is an intermediary between investors and the markets, but really a broker can be much more than that.
They have to be able to explain to their clients the features and risks of a financial product. They have a ‘duty of care’ to offer a service and recommend products that are right for each client.
Some products are suitable for most investors, but some are suited to only a few. A good broker has to fully understand the products and tell the client which are right for them, their features, benefits and risks.
A successful broker will be more of a relationship manager than someone who simply buys and sells. You have to keep in touch and earn the trust of your clients, because they’re giving you their money.
How does it work?
The relationship starts when an investor comes to a broker.
The client could be a fund manager who wishes to ‘hedge’ risk. Hedging is like having an insurance policy to help reduce your risk.
Fund managers are hedgers. They hold shares for their clients, and their risk is that the stock markets could fall, so they’d have ways to reduce that risk.
The second type of person using a broker would be a ‘speculator’. A speculator is somebody who wishes to try to make financial gain from the movement in the price of a financial asset like a share or a commodity (oil, gold, gas and so on) or an index, which is a group of shares.
Are these products suitable?
When brokers first meet a client, they do a ‘suitability test’, which is required by the Financial Markets Authority.
They have to make sure the products they sell are suitable for each client, with the exception of wholesale clients, who are professionals.
They’ll discuss the market they’re looking at trading in – shares, commodities or foreign exchange, for example.
Then the broker outlines the products that are available to trade in that market, how they work and how the trades are made.
If a client’s new to trading, the broker might need to explain what tools there are to help reduce risk, and how each works.
The client decides which product they’d like, and gives instructions to the broker.
The broker then runs through the order on the phone or by email. This is to confirm what level they want to buy or trade the asset, and how they plan to protect their risk.
With speculators, the broker may set ‘take-profit’ orders which will automatically close your trade once you reach a set profit target.
Placing the orders
When the broker and client have agreed risk and reward levels, the broker will place orders in the market. This is done using electronic dealing platforms that link them to the global markets for futures, shares, commodities, and foreign exchange.
Once the trades have been placed, clients get a follow-up call or email to say the orders are now working.
Brokers will follow this up by keeping the client up to date with relevant analysis, news and information from sources around the world.
Clients can even be texted market alerts, so they can act quickly to try to avoid losing money.
First published 21 February 2019
Story by Kevin Morgan, OMF
This article does not contain any financial advice and has not taken into account any particular person’s circumstances. Before relying on it, we recommend you speak with a financial adviser. This story reflects the views of the contributor only. Content comes from sources that we consider are accurate, but we do not guarantee that the content is accurate.
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