What Is a Bucket Shop?

A bucket shop is an unethical business that lets customers bet on stocks and commodities. Historically, bucket shops where little more than gambling establishments. The main difference between a bucket shop and a legitimate brokerage was the ownership of securities. A real brokerage would buy and sell stocks and other securities that are owned by its clients. A bucket shop would place so-called trades for customers without necessarily buying or selling the securities. Today, the term "bucket shop" can also be used to refer to any brokerage that regularly engages in unethical practices.

KEY TAKEAWAYS

  • A bucket shop is an unethical business that lets customers bet on stocks and commodities.
  • Historical bucket shops often did not actually hold or trade securities, so they could only profit if their customers lost money.
  • Today, the term "bucket shop" can also be used to refer to any brokerage that regularly engages in unethical practices.
  • The worst problem with bucket shops is that they have a conflict of interest with their customers.

Understanding Bucket Shops

Bucket shops have a long and storied history, so the meaning of the term has changed over time.

In the late 19th century, the spread of telegraphs and the growth of financial markets made bucket shops possible. It was possible to learn about stock prices, yet it was still difficult for ordinary people to participate in markets. The bucket shops stepped into this void by letting customers bet on stocks, just as people bet on horse races.

Bucket shops often did not actually hold or trade securities, so they could only profit if their customers lost money. Making customers use high leverage, typically around 1,000%, was standard practice. When stocks went up, customers would seem to make a fortune, attracting new customers. However, a decline of just 10% would be enough to wipe out the customers. If the market got too bullish, the bucket shops would engage in "bucket shop drives" to push down prices by about 10%. Most bucket shop customers eventually lose everything. Jesse Livermore became a legend by beating the bucket shops at their own game.

Most bucket shop customers eventually lose everything.

Bucket shops are sometimes called the boiler room. The U.S. has laws restricting bucket shop practices by limiting the ability of brokerage houses to create and trade certain types of over-the-counter securities.

The second definition for a bucket shop comes from more than 50 years ago, when bucket shops would do trades all day long, throwing the tickets into a bucket. At the end of the day, they would decide which accounts would get the winning and losing trades. This practice is incredibly illegal by today's standards and regulations.

Criticism of Bucket Shops

The worst problem with bucket shops is that they have a conflict of interest with their customers. Bucket shops typically profit at the expense of their customers. Legitimate brokerages usually do best when their clients succeed in increasing their wealth. Historically, many people started with stocks at the bucket shops because they did not require very much money or official credentials. These bad experiences created a negative perception of the stock market among the public. The mistaken notion that honest brokers somehow win or benefit when their clients are wiped out is a legacy of the bucket shops.

Examples of Bucket Shops

The use of dishonest sales tactics can make a firm a bucket shop. A fraudulent brokerage firm that uses aggressive telephone sales to sell securities they want to get rid of is a bucket shop. The securities they sell are typically poor investment opportunities, and almost always penny stocks.

Failing to trade promptly and keeping the price difference is another way for a brokerage to become a bucket shop. Suppose that a brokerage makes a trade on a client's behalf and promises a specific price. However, the brokerage waits until a different price arises. The brokerage then makes the trade and keeps the difference as a profit. This practice is called bucketing, which makes this brokerage a bucket shop.