I know almost nothing about buying/selling stock and brokers. (With two exceptions [1], all my investments have been the "buy shares of a mutual fund and hold it forever except for occasional exchanges with other funds I'm going to hold forever, or when I need to make a big purchase like a new car" kind of investments). Thus, I'm quite confused here.
What is this "deposit" in this case?
Could someone walk through what happens in this case: I have $X at my cash account at a broker, and I direct that broker to buy something that will cost $Y (including any broker fees, commissions, required tax withholding, etc.), where Y <= X.
I presume that ultimately I end up wit the thing I wanted to buy, and my cash account ends up with $(X-Y)?
So what happens as a step along the road to making that happen that requires the broker to use money that is not money from my cash account?
[1] In 1998 or 1999, the newsreader I used on Red Hat started corrupting my .newsrc after an update. I tracked it down to a change in one of the ctype macros in the C standard library. The newsreader assumed that all the flags fit in a char, which had been true before the update, but now wasn't. I submitted a patch that changed one declaration in the newsreader from "char" to "unsigned short". When Red Hat was going to IPO, I was surprised to get an email telling me that since I was a contributor to Red Hat, I could buy Red Hat stock at the IPO price. I bought a few thousand dollars worth that morning at $14/share, sold them that afternoon at something like $70/share, transferred the money out, and never touched my ETrade account again.
Who says submitting patches to open source doesn't pay? :-)
The other time was when T-Mobile gave every customer one share of stock. Eventually they got tired of having to deal with having a bazillion people who owned one share each of their stock, and told us we had to transfer our shares to the broker of our choice or sell. I sold.
The reason the deposits are necessary is that there is no inherent trust between the firms on settlement day. The deposits are the Brokers saying, "Hey, trust me, I've got everything I need to complete the settlement, here's my collateral".
As such, if a Broker doesn't have the funds to complete the transaction, you can pull it from their deposits.
Your money doesn't really play a part in this, and indeed the illusion of "give $X for Y stock" is just an illusion.
So if I tell a broker to buy $X worth of some stock for me, is what actually happens that the broker buys $X worth of that stock using their money, and then when that has completed a couple days later the broker takes $X from my cash account and transfers the stock to me?
No, when you tell a broker to buy $X of stock, they send a record of that purchase to a clearing firm. The clearing firm, in order to make sure none of the Brokers becomes insolvent before settlement, requires every Broker offer up collateral - it's collateral, it's not spent if everything goes well.
It's the SEC requiring brokers offer up insurance in case they explode.
Then, 2 days later, your actual money goes to the clearing firm and is exchanged for stock.
And this is why it’s confusing to the unsophisticated investor. Why didn’t they send my money in the first place? They can call it 100% collateral if they really want, but it’s basically payment up front. Once they get the stock I asked for, they take the money.
I suspect there are a lot more complicated trading mechanisms that take advantage of that 2 day gap that make my plan unfeasible though.
Would also like to know the answer to this. From the amount of people explaining the nuance of the deposit rules it seems many people expect trading to work the way you've described. The fact that it (counterintuitively?) doesn't seems like it might be a flaw in the system.
What is this "deposit" in this case?
Could someone walk through what happens in this case: I have $X at my cash account at a broker, and I direct that broker to buy something that will cost $Y (including any broker fees, commissions, required tax withholding, etc.), where Y <= X.
I presume that ultimately I end up wit the thing I wanted to buy, and my cash account ends up with $(X-Y)?
So what happens as a step along the road to making that happen that requires the broker to use money that is not money from my cash account?
[1] In 1998 or 1999, the newsreader I used on Red Hat started corrupting my .newsrc after an update. I tracked it down to a change in one of the ctype macros in the C standard library. The newsreader assumed that all the flags fit in a char, which had been true before the update, but now wasn't. I submitted a patch that changed one declaration in the newsreader from "char" to "unsigned short". When Red Hat was going to IPO, I was surprised to get an email telling me that since I was a contributor to Red Hat, I could buy Red Hat stock at the IPO price. I bought a few thousand dollars worth that morning at $14/share, sold them that afternoon at something like $70/share, transferred the money out, and never touched my ETrade account again.
Who says submitting patches to open source doesn't pay? :-)
The other time was when T-Mobile gave every customer one share of stock. Eventually they got tired of having to deal with having a bazillion people who owned one share each of their stock, and told us we had to transfer our shares to the broker of our choice or sell. I sold.