DEFINITION of Principal Orders

A principal order, or what is often called a principal trade, is a special type of order carried out by a broker-dealer which involves the broker-dealer buying or selling for its own account and at its own risk, as opposed to carrying out trades for the brokerage's clients.

BREAKING DOWN Principal Orders

When a broker-dealer is acting on its own behalf, as opposed to brokering transactions for its clients, it must properly denote to the exchange that it is doing so.

There are two primary types of trades: a principal trade and an agency trade. With an agency trade, a broker is trading for the benefit of a client and is compensated by a commission. In the case of a principal trade, a dealer will act as a broker as well, trading from their inventory they charge a spread as a fee.

A natural question arises: why would an entity act as a broker-dealer and trade from an internal inventory of securities? While there is no simple answer, it really boils down to what is in the best interest of a client.

Reasons for Principal Orders

Principal orders are almost exclusively an institutional investment matter -- rarely would a retail client need the features of a principal trade. The benefits of a principal trade largely include trade execution and trade costs. For specialized orders or orders requiring immediate execution (or a mixture of both), an agency trade may not meet a client's needs. To help serve the client best, or even in their best interest, perhaps it makes the most sense for a securities dealer to also act as a broker, and buy/sell from internal inventory.

For instance, if a large institutional client wanted to buy a certain stock in a hurry, it might not be able to fulfill a large block order without signaling intentions to the market. Here, a broker-dealer, valuing that relationship can sell the wanted stocks directly to the client in a semi-private transaction. The broker-dealer makes it clear it is selling from its inventory and if the client is fine with it, there's been no breach of confidence.