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I'm new to finance, thus please fix me if i misunderstand something.

As far as i know, one can get an account on a brokerage firm, and have ability to trade on multiple exchanges. Good use case for that is for example if there is a volume available for your trade on multiple exchanges you just put one order which might be broken down to several other orders and sent simultaneously to target exchanges using best opportunities.

Each exchange is exposing an api and has its account system, so that an account on an exchange is executing a trade then it shall have enough assets for that.

So i want to understand how does the brokerage work? does it hold accounts with lot of assets on each exchange then execute trades on demand just predicting optimal amount of assets to be held on each exchange? or there is some other mechanism for this to work?

Another option i can think of is if there is a trust between exchanges to the brokerage so that if the firm sends an order to exchange it assumes that brokerage holds assets required for that...

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Brokerages offer you the convenience of buying and selling financial products. They are usually not exchanges themselves, but they can be.

Typically there is an exchange and the broker sends orders to that exchange. The main benefit that brokers offer is a simpler commission structure.

Not all brokers have their own liquidity, but brokers can have their own allotment of shares of a stock, for example, that they will sell you when you make an order, so that you get what you want faster.

Regarding accounts at the exchanges to track actual ownership and transfer of assets, it is not safe to assume thats how that works. There are a lot of shortcomings in how the actual exchange works, since the settlement time is 1 - 3 business days, depending on the product (so upwards of 5 to 6 actual days). In a fast market, the asset can change hands many many times making the accounting completely incorrect for extended time periods. Better to not worry about that part, but if you'd like to read more about how that is regulated look up "Failure To Deliver" regulations on short selling to get a better understanding of market microstructure. It is a very antiquated system.

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The brokerage executes the transactions you tell them to make on your behalf. Other than acting as your agent for those, and maintaining your account, and charging a fee for the service, they have no involvement -- they do not attempt to predict optimal anything, or hold any assets themselves.

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  • So basically if i want to sell some stocks of XYZ and there are few exchanges with orders satisfying the price i want to sell, i need to do calculation myself and send the orders to the firm? it like only gives me api to work with other exchanges? – vach Sep 14 '15 at 0:48
  • could you please suggest any docs for me to read on this? seems i'm misunderstanding a lot of things – vach Sep 14 '15 at 0:50
  • I'm not sure what you mean by "other exchanges"; the broker is not an exchange. Brokerages will let you do some basic programming of the transactions -- more complex if you pay more -- but it's up to you to tell them what to do., though they may advise. If you want and trust them to manage your money on your behalf, that's what mutual funds provide; see discussion elsewhere of the fact that fully automated "index funds" tend to outperform supposedly more sophisticated human-managed funds after fees are taken into account. – keshlam Sep 14 '15 at 1:25
  • Well, in theory this answer is correct, but in practice most brokers nowadays do not operate this way. They are heavily involved in making money themselves by trading in advance of -- or even counter to -- their customers. But for someone learning the basic mechanics of brokerages, then it's okay to think of them as independent agents acting on their customers' behalfs. – dg99 Oct 14 '15 at 16:44
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Real target of commisions is providing "risk shelter".

It is kind of "insurance", which is actually last step for external risks to delete all your money. In part it cuts some of risks which you provide, brokers track history of all your actions for you (nobody else does).

When brokerage firm fails, all your money is zero. It depends from case to case if whole account goes zero, but I wouldn't count on that.

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    This isn't remotely right. In the US, brokerage customers are protected by SIPC. – zeta-band Jan 10 '17 at 21:56
  • @zeta-band and take all your money via commissions, yep – sanaris Apr 15 '17 at 13:40

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