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Strategies & Market Trends : From the Trading Desk -- Ignore unavailable to you. Want to Upgrade?

To: Whipsaw who wrote (2469)	1/29/1998 7:25:00 AM
From: steve goldman	Read Replies (2) \| Respond to of 4969

Principal vs. Agency Distinction - This might be already well understood by most on this thread, but I figured I would rehash it for those who aren't familiar with the lingo. There are essentially two roles a firm can take in client orders. They can act as a principal or as an agent. Agency firms are firms that represent your order without making markets or acting as a principal. They don't and CANNOT take the other side of your trade. Therefore ifyou are selling 1000 abcd, it is not bought by the firm and sold to someone else at the profit. Rather, the firm sells your stock and whatever they get for it in the open market, you get. If they sell abcd at 15, you get 15. Firms that act as principal take a position in the trade. Their objective (how they make a profit) is to take in your stock into their firm inventory at the bid, lets say 14 7/8 and sell it in the open market at 15. This 1/8 point, they keep. Its their profit. Sometimes its a lot more, sometimes it less. Nonetheless, in doing business with a firm that makes markets or acts as a principal, you must understand that they are in the end, trading against you. Every 1/8 or 1/4 price improvement that can be achieved, they keep. Its their profit. A dollar more in your pocket is a dollar less in theirs. Firms that act as principal must dislose this regularly and must indicate it on confirmations. They aren't going to put up big signs that says they are trading against you. Its usually a number on your confirm that states their role in the trade. You don't need to be a market maker to act as a principal. For instance, syz firm, who might not be a market maker in dell, might take you dell into their firm account at the bid and sell it to another customer at the offer, instantaneously. The firm might not be a market maker, but still acted as a principal in the trade. The firm might take you stock intotheir account and try to get an 1/8 or 1/4 better on selectnet. They get that improvment as they are a principal. You might think this sounds wrong, but it is how business is done on Wall Street. You agree to it when you sign the new account documents. Personally, given the rate at which we get price improvements and the rate we protect orders, we feel it is better to do business with a firm that DOES NOT make markets or act as principal. If you are selling stock and can get a 1/8 or 1/4 more on the trade, thats a lot of money that goes towards any additional commissions you might pay at such a firm. As well, imagine a stock you put in a buy limit on is tanking and the order could be pulled safely and let the stock tank. Perhaps you could get 1/8, maybe a 1/4, if you are really luck 3/8 or 1'/2 and if everything went your way (which happens regularly) you might get even more. The point is, at a firm that makes a market or acts as principal, you never know. They aren't there to get you improvements. They have very skilled traders, who sole job it is to take your order and make a profit for the firm on it. If you look back to Chris Smith's postings, he talked about how he market up trades 1/4 or more. As well, firms can legally mark up trades upto 5%. Also, note that a lot of online firms do not make markets or act as principals but simply nondiscrimintorily route every order to such a party. The market makers pays the firm order flow for such routing of the orders since they want to make a market and make a profit on the customer order. Usually, the market maker pays about $20 per 1000 shares....So right away you get an idea of how valueable the order flow is for themarket maker and how much he thinks, on average, he can make on the trade...atleast the $20 he is paying for it. An nobody invests $20 to simply make 20...Rule of investing, invest 20 for a percentage return on the 20.....thought you might be interest in that. This is why we have our market niche. The active (notsuperactive) trader who knows how much a 1/4 on 1000 shares is and is willing to pay $20 bucks more for the trade. Its given us twenty years of great success. Most firms would rather do trades for $19.99 and then get 20 in order flow or get $125 on making an 1/8 or so. I'd rather get $35 or so for the trade and know we did well for the client. Its one of the reasons we lose less than 1/4% of our clients each year, which must be one of the lowest ratesin the industry. There is a good discussion on principal vs. agency and execution quality on the yamner website at yamner.com go to Yamner Univ and then the Yamner library. Regards Steve@yamner.com