Understand Your Commodity Broker

Despite the impression that you may have gotten from watching the movie “Trading Places” or reading industry publications, being a broker has few perks…unless you are good at what you do.  The industry is commission based and has the potential to be lucrative for those who are willing to put forth the effort.  When it comes to being a successful broker, effort is synonymous with an open mind and a constant yearning for information,  a commitment to providing unparalleled service and networking with floor brokers to ensure efficient execution for their clients.  The hours are long, but it is easy to see how one could fall in love with the excitement of it all.

For those who fail to put forth the effort necessary to make a decent living as a commodity broker, the pay is hardly worth the time.  In fact, there is a high probability that a fast food chain or even unemployment benefits would pay more.  In my experience, I estimate that about 80% of the brokers in the commodity industry fall into this category.   The other 20% make a respectable living, hopefully through providing their clients with the service that they deserve at a reasonable price.

A big concern facing the industry is the fact that brokers are provided incentives in the form of commission.  Those who are short-sighted and fail to employ a long term business plan are tempted to churn, or overtrade, accounts.  Accordingly, they may encourage clients to trade in an attempt to increase their commission check without always holding regard to the best interest of the client. 

Ironically, it seems as though many of the brokers who approach their clients aggressively in an attempt to generate commission fall into the 80% of brokers who struggle to survive.  There are a few steps that you can take to evaluate whether your broker fits your needs as a trader and is qualified to earn your business.

The NFA Website (www.nfa.futures.org)

Once you Have determined your candidate for a brokerage firm, you should visit www.NFA.Futures.org to access their BASIC (Background Affiliation Status Information Center) database.  The database contains CFTC (Commodity Futures Trading Commission) registration and NFA membership information.   The site will give you the ability to submit a query on your prospective brokerage firm and the individual broker.  The information provided will include the length of your broker’s registration and a list of regulatory actions, NFA arbitration awards and CFTC reparation cases in which the broker has been involved.  Keep in mind that a CFTC reparations claim doesn’t infer guilt; many of the claims may have been settled, dismissed or withdrawn. However, you may want to confront your broker in the matter.  You may also find information on any NFA arbitrations which is a dispute resolution rather than a regulatory action and any regulatory actions.  I am sure that you would agree than knowing whether your broker may have been party to questionable practices in the past can be important. 

Get to Know your Futures Broker

You probably wouldn’t choose a business partner in which you haven’t established the potential for efficient communication, have confidence in their ability to bring something positive to the relationship and most of all trust.  Why would you think of choosing a broker without doing these things? 

Becoming familiar with your broker before you ever begin trading is a significant step in the right direction.  The vital areas of concern are their educational background, experience in the industry and, most important, general market knowledge.  A college degree in finance isn’t necessarily a reason to open an account with someone and neither is the fact that he or she has been in the business for twenty years. However, considering these factors in conjunction with a well-rounded grasp of market characteristics and proper lines of communication are key.  You should be able to determine whether a broker fits your needs and personality with a twenty to thirty minute conversation.  During this time, don’t be shy.  If they want to do business with you, they must be able to answer your questions assuming they are reasonable.

Work Ethic

In order for you to be a successful  trader you must have access to your broker.  If he is hard to get a hold of or slow to return your calls and emails, you should strongly consider shopping around for another broker.  Many brokers feel as though once the markets close they are off duty and free to leave the office, however, doing so isn't making themselves available for their clients.   Those paying full service rates deserve better. 

Work Experience

This may seem like none of your business but that is where you are wrong.  Think about it, if you were interviewing someone for a position as a convenient store clerk, one of the first things that you would require is a list of prior employers.  When you open an account with a broker you are in essence hiring them to provide you with service, knowledge and honesty.   Arguably, this position requires more experience than a cashier and the interrogation should be at least as extensive.  In my opinion it is absolutely necessary to know what type of skill the broker can offer you and this includes knowing their employment history. 

Naturally, you wouldn’t want to be irrational in your quest for information, a general idea will be enough for you to properly evaluate the service you will be paying for.  Remember, the only requirement to being a commodity broker is passing the series 3 exam.  In other words, although the proficiency exam is challenging the bar isn’t set incredibly high.   I am not trying to paint a negative picture for you, but I also want you to keep your eyes open to the realities and encourage you to know who you are dealing with.

Trading Background

Don’t be afraid to ask a prospective broker how long she has been involved in trading.  Her experience in the markets may pre-date her days as a broker.  Also, ask whether she is trading a proprietary account or for friends and family.  If the answer is no, you shouldn’t be immediately turned off.  In fact, trading a personal account is seen as a conflict in the industry.  As a result, brokers often have to “take a back seat” in their trading.  For example, preferable fill allocation always goes to the client while the broker receives the least favorable fill on a block ticket.  While I agree with the concept, it leaves a broker slightly behind the curve.  Additionally, I think that you will agree that you would rather have a broker that puts you and your account before hers. 

Furthermore,  though the most basic function of a broker is to execute your trades,  if you plan on using your broker for trading guidance you likely wouldn’t want to do so from somebody that has never traded or had real money on the line.

Trade Execution

Perhaps one of the most important aspects of the service that your prospective broker can offer is execution.  When it comes to electronically traded contracts such as the e-mini there is very little, if any, difference between firms assuming that the trading platform is reliable.  However, when it comes to open outcry execution the difference in brokers can be tremendous.   An experienced retail broker will have contacts directly on the trading floor that are capable of providing accurate bid/ask spreads as well as efficient and effective fills.  Floor brokers charge what is called a “give up” fee, normally between $2 and $4 but the fill quality is worth far more.  If you intend to do a significant amount of open outcry option business (spreads, or those contracts only traded in pits) I strongly recommend working with a broker that is capable of executing your order through a “give up” firm.

In Conclusion

Unfortunately, the opportunities in the futures markets attract attention from individuals with a “get rich quick” mentality.  This is true of brokers, traders, system vendors, etc.  Given the ease at which it is to become a commodity broker and the false assumption that being a broker can be lucrative with minimal effort, many are drawn to the profession for the wrong reasons.   Accordingly, many commodity brokerage careers are cut short by the realities of the business.  Make sure that your broker is in it for the long haul before investing too much time into the relationship.

*There is substantial risk in trading options and futures.

Carley Garner, senior analyst at DeCarley Trading, is the author of "A Trader's First Book on Commodities" and “Commodity Options” published by FT Press, a division of Prentice Hall.  Her trading e-newsletters, The Stock Index Report and the Bond Bulletin, are widely distributed and have garnered a loyal following; DeCarley Trading is proactive in providing free trading education.