Principal trades involve a brokerage's own inventory of securities, while agency trading involves trading with another investor, potentially at another brokerage.
Principal trading occurs when a brokerage buys securities in the secondary market, holds these securities for a period of time, and then sells them.
The purpose behind principal trading is for firms (also referred to as dealers) to create profits for their own portfolios through price appreciation.
So, when an investor buys and sells stock through a brokerage firm that acts as the principal, the firm will use its own inventory on hand to fill the order for the client.
With this method, brokerage firms earn extra income (over and above the commissions charged) by making money from the bid-ask spread as well.

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