When it comes to executing equity trades, investors can choose between two main approaches, risk trading and agency trading.
Each has its advantages, its trade-offs, and a very different relationship to price, speed, and execution certainty.
Understanding how these two models work is key to knowing what's really happening when an order hits the market.
Let's start with risk trading.
In a risk trade, the broker or dealer takes the other side of the client's order immediately quoting a two-way price and executing the trade on the spot.
For example, an investor might say, I want a two-way price in 1 million.
BP London, which refers to BP shares trading in London, so BPLN, the broker responds with a bid and an offer price, and the client decides whether to sell or buy.
This kind of interaction often happens through what's called an RFQ process.
Short for request for quote, the client sends a pricing request to one or several dealers asking them to quote a firm price at which they're willing to trade.
Once the quotes come back, the client can choose which one to hit, agree to sell at, or Lyft agree to buy at.
Once the trade is executed, the risk transfer is complete.
The client has locked in a price and eliminated exposure.
That's the main advantage.
Speed and certainty, however, that certainty comes at a cost.
The client typically pays the bid.
Ask spread, selling at the lower bid price, and buying at the higher ask price, which compensates the dealer for taking on market risk.
The larger the trade, the wider that spread is likely to be because the dealer is committing more capital and faces greater exposure before they can hedge or unwind the position.
In other words, the client is paying for immediacy, and immediacy has a price.
There's also a strategic balance to strike.
If the client sends the RFQ to too many banks, information can leak and the market may move against them, but send it to too few and they might miss the bank most eager or axed to trade in that name.
Now contrast that with agency trading.
Instead of the dealer taking the risk and quoting a fixed price, the broker simply acts as an intermediary working the order on behalf of the client rather than taking it onto their Own book.
The broker may execute gradually throughout the day using both exchanges and dark pools to find offsetting buyers or sellers.
A typical instruction might be, please work to buy 1 million BPLN London over the day.
Because the broker is acting purely as an agent, the client must provide clear execution instructions.
For example, setting a limit price, a timeframe, or a benchmark to target.
The clear advantage of agency trading is the potentially lower cost execution. Spreads are usually tighter, and commissions for these low touch electronic orders tend to be cheaper than for high touch human handled risk trades.
If the broker finds offsetting counterparties, the client may achieve an even better blended price.
However, the trade-off is less certainty.
The clients will not know the final execution price until the order is complete, and if a limit is placed, there is no guarantee the order will be filled at all.
Since the broker may not be able to find another market participant who is willing to trade at that limit price.
