When I trade, where does the money go and come from?
November 9, 2007
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John Forman - The Essentials of Trading author
I received an email the other day with some questions that may seem very basic to most folks who read this post, but are the types of things folks new to trading and the market are curious about.
Question 1: Who am I trading with?
The counter-party to your trade depends on whether you are trading through a broker or with a dealer.
If you are trading exchange traded securities (stocks, futures, etc.) that you are probably doing so through a broker. As such, your orders are simply passed through to the exchange and matched up with another trader or investor there. You will never know who that other person or institution is.
In over-the-counter markets (some stocks, forex, some fixed income, etc.) you often will be trading with a dealer, which is a person or institution in the business of making a market in what you’re trading. That means they take the other side of your trade. That said, though, these dealers (market makers) are not in the business of taking positions in the market. They are trying to profit by selling at the offer (ask) price and buying at the bid over and over again. In other words, if they are buying from you they are looking to sell to someone else right away.
Question 2: Does the money I keep with broker remain with the broker?
This depends on what you are trading.
If you trade stocks where you actually buy and sell assets, then the money for those transactions flow in and out of your account. When you buy 100 shares of Google, your broker sends the cost of that purchase to the account of the broker or institution from which the shares were purchased.
If you are trading futures or forex, which are margin-based markets, then the money stays in your account. These markets are agreement ones. You don’t actually purchase anything. The value of your account will change with the value of your position, of course, and you won’t be able to take the margin money out while you have a position on.
Question 3: Where does the broker get fund to pay for the profit I make?
Your broker does not pay you the profits you make. They merely move funds in and out of your account based on the transactions you make. Using the Google example above, if you purchased 100 shares at $500 your broker would take $50,000 out of your account to pay for those shares (plus commissions and fees, of course). If you then sold your Google position for $700, your broker would deposit in your account the $70,000 received for those shares from the purchaser of them.
Hopefully that answers the questions. By all means, if you have any follow-up inquiries to what I’ve said here, feel free to ask them via a comment.
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How can an investor be sure his on-line broker is recording the transactions correctly in his account, particularly when it involves a merger? I’ve currently got a real headache going on. My 2008 1099-B and monthly Account Statement shows the merger transactions one way–resulting in a net gain–while the account Transaction History records them another way–resulting in a net loss. As it is now I’ll have to pay taxes on abut $23,000 I never received! Can you shed some light on this mess? I’ve got FINRA looking into it, but no solution yet.
Shirley – Without being able to look at the specific details I couldn’t begin to comment. Even then I’m no expert on those sorts of things. If I were in a situation like this I would first ask for written clarification from the broker. If that were insufficient I would then go up the ladder to the broker’s overseer. For a stock broker in the U.S. that is probably the NASD. Further up the ladder is the SEC. You may also want to see if there is a securities lawyer or securities tax specialist somewhere you could speak to about it all.