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Why are institutions knows as buy-side firms, and broker-dealers known as sell-side firms?

From what I understand, both institutions and broker-dealers do both buying and selling, so what is this basis of the buy-side vs. sell-side distinction? From Wikipedia:

In sales & trading, the split between the buy side and sell side should be viewed from the perspective of securities exchange services. The investing community must use those services to trade securities. The "Buy Side" are the buyers of those services; the "Sell Side", also called "prime brokers", are the sellers of those services.

By "services" I guess they refer to market-making?

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Traditionally, dealers and broker-dealers were in contact with the actual producers of a product or issuers of a security, selling it at the exchange on their behalf. Consumers would traditionally be on the buy side, of course.

These days, anyone can enter the market on either side. Even if you don't hold the security or product, you could sell it, and take on the risk of having to stock up on it by the delivery date in exchange for cash or other securities. On the other side, if you can't hold the product or security you could still buy it, taking on the risk of having to dispose of it somehow by delivery in exchange for cash or other securities.

In either case you (the sell-side) take on risk and provide products/securities/cash. This is most commonly known as market making. Modern literature coins the terms liquidity taker (buy-side) and liquidity provider (sell-side). Even more accurately, risk management literature would use the terms risk-taker (sell-side) and risk spreader or risk reducer (buy side).

This is quite illustrative in modern abstract markets. Take a market that allows for no offsetting or hedging because the product in question is abstract or theoretical, e.g. weather trading, volatility trading, inflation trading, etc. There's always one party trying to eliminate dependence on or correlation to the product (the risk reducer, buy-side) and the counterparty taking on their risk (sell-side).

  • Thanks. What is confusing is this: institutions are buy side but brokerage houses are sell side, but most institutions and banks have their own brokerages. This is very confusing. – Victor123 Jan 17 '14 at 15:28
  • Yes, but the brokerage department of an institution is regulated (and probably incorporated) differently, e.g. Brokerage: JP Morgan Securities LLC, Clearing: JP Morgan Clearing Corp., Asset holders (buy-side) on the other hand are subsidiaries of JPMorgan Chase Bank, N.A – hroptatyr Jan 17 '14 at 16:53

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