Considering the wide scope of opportunities that the stock market presents, there is certainly a need for traders to make use of all the resources they can get. The primary of these resources that are essential for every stock market investor is a reliable stockbroker or stockbroking agency.
But that leads us to the next point – what exactly takes place when you sell or purchase a stock by the means of a stockbroker? This is where the matter of principal trading vs agency trading comes in. These two concepts are essential to understanding the behind-the-scenes process of dealing in the stock market via a stockbroker. To help you understand these topics and the difference between them, here is a closer look at the difference between principal trading and agency trading.
What is Principal Trading?
Let us first get some perspective on the principal vs agency trading distinction by reviewing the two concepts, starting with principal trading. Principal trading is essentially the type of trading carried out by stockbrokers whereby they buy stocks from a secondary market, hold them for a given period of time and then eventually sell them. It is important to note that in principal trading, the stockbrokers buy or sell stocks solely for the purpose of their own account and not for their clients’. The stockbrokers execute transactions on their own behalf and do not act on behalf of their clients.
This is because the primary purpose of principal trading is for the stockbroking firms to benefit from price appreciation and yield profit for their portfolios. An important thing to note here is that in order to engage in principal trading, a stockbroker has to inform the exchange at which the stock transactions are to take place. This helps the process of trade regulation for large orders and ensures that regular investors are shielded from unethical practices such as insider trading.
What is Agency Trading?
Next up on the topic of principal vs agency trading distinction is the definition of agency trading. Agency trading is the form of trading conducted by a stockbroker whereby they seek and transfer stocks between various clients belonging to different brokerages. This type of trading is done on behalf of the stockbroker’s clients and is a far more complicated process than principal trading. Hence, the stockbroker charges its clients a predetermined amount of fee, known as commission, for its services.
The simple way to understand agency trading is that the stockbroker takes your transaction request and then seeks another party that is looking for a similar transaction on the opposite end. For example, if your transaction request to your stockbroker is for a sell order at a certain price, the stockbroker will seek a transaction request for a buy order at that price. Once both of these parties are found and the transaction is concluded, it is documented as an agency trade on the appropriate exchange.
What are the differences between principal and agency trades?
Now that you understand the two concepts in question, let us review the principal trade vs agency trade distinction.
The primary difference between a principal trade and agency trade is the question of who benefits from the trades and who bears the risk. In the case of principal trading, trades are executed entirely for the benefit of the stockbroker and for their own portfolios. This also means that principal trades are executed at the risk of the stockbroker and not its clients. In the case of agency trades, however, traders are executed solely on behalf of the clients. This means that the risk of the trades are borne by the individual investor and not the stockbroker.
Another distinction between principal vs agency trading is the matter of who they are largely conducted for. In the case of agency trading, it is mostly conducted for individual investors trading in the stock market. Each transaction is executed by the stockbroking firm and the goal is to fill the client’s order by seeking order requests from other investors.
In the case of principal trading, it is done for the stockbroker’s institutional investment benefit. The only exception would be clients with unusually large orders, for which the stockbroker might utilise some of its own inventory.
These differences between principal trading and agency trading can help investors in the stock market, new and old alike, to gain a better perspective on the overall process of trading. As a stock investor, you have the right to be informed by your stockbroker how your order was fulfilled – whether by principal or agency trading. In either case, it is always advised to align yourself with a reliable stockbroker with a solid reputation in the industry.