As the name suggests, a broker “brokers” a deal between two parties. A broker generally never buys or sells stocks himself, being instead the middleman between the investor and the market, and either sending an order to a market where it can be executed or finding the other party to the trade directly.
A broker makes sure to only execute trades that the investor can afford. And in case of derivatives, it makes sure that the investor has got enough margin, so that when they need to pay the counterparty they can actually honour the contract.
Brokers usually provide more value-added service to their clients, like data/research service, margin service, execution consulting and so on.
A dealer, instead, is usually on the other side of the trade and you will be buying or selling with the dealer himself as the counterparty. This is usually done in less liquid securities like municipal bonds or penny stocks.
Dealers generally operate in the Over-the-counter (OTC) market, where you can only see and compare the quotes the dealer make to you, with the ones of different dealers, but there’s no centralised place that displaces all quotes.
In exchange, you don’t know who you are trading against, but you do in OTC market. That could be important if the identity of trader has information content, especially on the price of the product being traded. The flexibility in pricing is a great plus for dealer in OTC market.
A dealer usually operates with tons of capital, because he has to hold a little bit of everything to be the middleman and sell you whatever you demand, or buy whatever you want to get rid of. A bond dealer usually has billions of pounds worth of bonds, as bonds are all different because they have a different maturity, different yield, etc. Dealers often create an inter-dealer network so they can supply products to you that they don’t currently own, or unload excessive inventory to other dealers.
A market maker (MM) is obligated to make markets in specific securities, meaning they both bid (to buy) and offer (to sell) the stock at the same time. They trade for their own account and generally try to make money from the spread (the difference between the bid and offer). A market maker doesn’t need much capital to operate when compared to Dealers.
A market maker generally stands in an Exchange, a place where everyone trades against everyone. Stocks, options and some bond and FX trades on exchanges.
Today high-frequency traders dominate the MM business.
One more difference, to conclude, is that the success of a dealer mainly depends on good (personal) relation between clients and other dealers, whereas that of a MM depends on its technology and research team.
