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Selecting your
Broker
One of your more
important decisions when trading futures and related options is the
broker you will use. Some time ago, choices were limited by fixed
exchange margins and commission rates. All brokers were required to
adhere to the same schedule of fees and margins established by the
exchanges. When fees were deregulated, investors were treated to a
wide range of services. Today, you can trade through a discount
broker, use "full service," or even place orders
electronically through the Internet.
Your decision
concerning brokerage is extremely important because your profit
performance can be affected. Commission rates can be as low as $15 per
round-turn at a deep discount broker if you maintain a high trading
activity and healthy account balances. More common discount rates
range from $25 to $40. Full service commissions usually begin around
$40 and can be as high as $125. A "round-turn" commission
refers to a completed transaction; into and out of the market. Some
brokers may charge you on a "half-turn." For options, some
brokers may charge the full commission when you enter your trade and
nothing when you exit.
While logic
dictates that "you get what you pay for," this is not always
the case when seeking brokerage services. Some discount firms provide
excellent support. Some "full service" companies can be
disappointments. The criteria for selecting whether to use discount or
full service depends upon the support you need and the service you
desire. Some traders want nothing more than an order desk... no
comments, opinions, or information. This is ideal for using a discount
firm. Moreover, the greater the discount, the better.
On the other hand,
you may want help in placing your order or understanding market
conditions. You may seek an opinion or an explanation of how to use
stops and limits. In such a case, full service can make more sense.
Regardless of whether you use discount, full service, or something
in-between, you want an efficient firm that will provide good
execution performance. Because commodity and option prices can move
very quickly, your executions or "fills" can vary from
minute to minute or from one broker to another. This is because
different brokerage firms may use different order processing routines.
You may be familiar
with the term, "at the floor." This refers to placing orders
directly with floor traders. This is usually considered the most
time-efficient method of entering trades. However, the floor is
usually a very busy place. It is not likely that you will be allowed
to chat if you are truly "going to the floor." Most
brokerage firms have an "order desk." This is a department
of experienced trading clerks or brokers who receive your orders and
call them to their floor brokers. This is normally considered the
second most time-efficient way to trade. Again, trading desks are very
busy and don’t usually have time to discuss your trade. When going
to the floor or using a trading desk, you should be well organized.
Make sure you don’t double-enter a trade or forget to cancel a stop
when leaving a market. Neither the floor broker nor the trading desk
have time to check for your errors.
The most common
association is with a personal broker. This is a relationship where
the broker knows you and your trading style. Your broker monitors your
account and is familiar with your positions. Certainly, you must
remain well organized and avoid errors even if you have a personal and
responsible broker. However, your broker can frequently catch possible
problems and he or she clearly has an incentive to help you trader
better to continue earning commissions. Your personal broker takes
your orders and calls them to the floor or sends them through his own
desk for execution.
If you use a
personal broker, you are likely to pay a higher commission. Of course,
if you have a large account with high volume, your rates may be
lowered to near or at discount. The most important criteria when
choosing a broker is honesty. It is often a good practice to call the
National Futures Association for a background check. Find out if there
are any complaints or disciplinary proceedings filed. Determine the
nature of any such problems. Be careful in your evaluation of any
broker. Keep in mind that a sanction for a bookkeeping error is far
less significant than a suspension for a ponzi scheme! If a broker you
are considering has a problem on the NFA record, ask the broker for an
explanation.
Most brokers are
honest and hard working. Therefore, the next criteria is experience.
There is no substitute for experience... The longer the better!
Experienced brokers are familiar with all types of orders, strategies,
and market conditions. They are less likely to panic and more likely
to direct you to the right action under most circumstances. Some of
the best professionals are those who have multi-level experience. You
may have heard the distinction "upstairs" and
"downstairs" traders. An upstairs trader is one who works in
an office away from the exchange trading floor. A downstairs trader is
on or close to the floor.
If you can find a
broker who has worked on the floor of the exchange as well as in an
"upstairs" environment, it may be helpful. Having floor
trading experience gives insight into the way trades are processed and
how the "system" works. Obviously, there are many highly
qualified brokers who have never worked or even seen the trading
floor. Yet, floor experience is simply one more aspect you might look
for when selecting the broker or firm where you’ll trade.
Another point to
review is the registration status of the brokerage firm. There are
several types of brokerage companies including:
Guaranteed
Introducing Brokers
Self-Guaranteed
Introducing Brokers
Clearing Member
Brokers
Non-clearing
Member Brokers
Introducing Brokers
(IBs) are similar to selling agents for the larger "Futures
Commission Merchants" (FCMs). Those IBs that are guaranteed have
an exclusive relationship with an FCM that is willing to use its
capital to "guarantee" the IB. A self-guaranteed IB must
maintain its own minimum capital and can trade with one or more FCMs.
While the term "self-guaranteed" may sound less financially
secure than guaranteed, these IBs are generally very stable by virtue
of their willingness to maintain their own capital base. The National
Futures Association (NFA) maintains strict financial requirements for
non-guaranteed firms and carefully monitors compliance.
During the
financial uncertainty over the October 1987 Crash, it was observed
that IBs acted quickly to protect clients against the possibility of
failures by the FCM. This was a highly unusual situation, however, it
demonstrated that the loyalty of an IB is with its client base. This
is not to say that an FCM is any less loyal to its clients. It simply
illustrates that an IB can seek to move its clients if the FCM
exhibits financial instability or poor performance.
IBs use the
facilities of their supporting FCMs. FCMs maintain order desks and
relationships with floor brokers. Floor brokers may be independent or
can work for the FCM. FCMs may own seats on the exchanges. This
affords extra privileges including access to exchange resources and
better commission rates for the member firm. (Note: Member firms do
not always pass on the lowest rates to customers.) Clearing members
are an elite group of FCMs that maintain very large capital deposits
with exchange clearing firms. Clearing deposits are used to guarantee
transactions in the unlikely event of a default by both the trader and
the member firm. The clearing house provides the last line of defense
against defaulted transaction through its clearing fund.
When considering a
brokerage company, find out the registration status. See how the
firm’s standing might affect your trading account. Do you need to go
to the floor with your orders? Can you use the trading desk? Do you
have a relationship with a retail full-service full-product company?
Does it make sense to use a firm specializing in futures? These are
important questions.
COMMODEX trading
tends to generate a large number of trades. Therefore, commission
expenses are an important consideration. COMMODEX automatically
deducts an average commission of approximately $40 per trade from the
PROFIDEX figures. A $10,000 account following a modest COMMODEX
portfolio can experience between four and six trades per month. At $40
per trade, commissions can range between $160 to $240 per month. Over
a year, that’s $1,920 to $2,880... 19.2% to 28.8% of the account
equity. A $10 difference in commission rate translates into $480 to
$720 per year. Therefore, it is easy to see how commissions can impact
your trading.
Of course, bad
fills can be far worse than higher commissions. Consider that a
one-tick differential in treasury bonds represents $31.25. If a broker
charges $60 in commission and consistently achieves better treasury
bond fills by one or two ticks, it is obvious that you are getting a
good deal. A very low rate with bad fills is no bargain!
One of the best
rules in commodities is to "know your broker" and make sure
your broker knows you. When you fill out your account papers, be as
clear and honest as possible. Never exaggerate your financial
statistics such as net worth or the amount of risk capital you have.
Be very cautious and avoid brokers who suggest being less than
truthful on your account forms. Read your forms carefully and ask for
an explanation on any item you don’t fully understand. Your decision
to trade futures and related options is important. You must enter into
a contractual relationship that has many rights and obligations.
Commodity futures
markets are exciting and potentially rewarding. A good relationship
with your broker will enhance this experience.
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