Does a Fair Commission Rate Trump a Low Commission Rate?

Fair Brokerage CommissionDoes a Fair Commission Rate Trump Low Commission?

Before it is possible to objectively look at commission rates, you have to understand the background of the futures industry. In recent years, advanced in technology has brought the futures and options markets closer to the average retail trader. As a direct result of electronic trading, futures brokerage firms implement tighter risk management techniques in their quest to prevent traders from losing more money than is on deposit. Accordingly, the barriers to entry have become nearly non-existent. Brokers are now willing to accept clients with much smaller account balances, charge less commission for their services and offer market access with less interference by risk management teams.


In general, this is a positive because it provides a broader range of product choices to those that otherwise wouldn't have been given the opportunity to venture into leveraged trading. Although technology has worked wonders for trading volume and, therefore, revenue generated on domestic futures exchanges, it hasn't necessarily improved the ability for brokerage firms and brokers to make a living. After all, exchange transaction fees go directly to the exchange and don't benefit futures brokerage firms; in addition futures brokers have (foolishly?) lowered commissions to a point in which profit margins are slim. In fact, discount futures brokers have essentially cannibalized the industry so much that some brokerage firms are operating on models that leave little or no profit incentive despite massive trading volume. Concisely, those brokers succumbing to lower commission rates to be competitive rather than offering service to attract clients, is following the "Netflix" path. They are offering their service at rates that make profits particularly challenging and as a result, they often operate prop trading desks or invest in risky assets to make up the difference (think MF Global).


Even worse, highly discounted commissions and low barriers to entry into the futures markets are the equivalent of penny machines in a casino located in a poverty-stricken neighborhood. It enables those that might not have the financial means, trading experience, or market knowledge to participate in a no mercy, high stakes game...the outcome is often unfortunate. Sadly, in contrast to many assumptions, the dramatic improvements in information flow and convenient technical analysis have failed to improve the odds of success. It is still believed that roughly 70% to 80% of traders lose money in the markets and my guess is that for those in their first year or two, the odds are probably much more dismal.


Too many beginning traders are absolutely not prepared for the challenges they will face in speculation. Compliments of easy access to leverage, along with speedy fundamental and technical analysis tools, "newbies" often fall victim to the idea that successful trading is as easy as buying the right software, subscribing to a news feed, and finding the cheapest commission rate available...which often entails self-directed online trading. This type of arrangement might be ideal for experienced traders, but for those that aren't yet accustomed to trading symbols, order types, market hours, market liquidity, and other basic factors, trading online might be a synonym for shredding money.


Traders are being "coached" into a mindset of saving money, rather than making money; what they don't realize is, as in everything else in life, they will get what they pay for. In the end, many of the green traders opting for a highly discounted commission rate, in lieu of quality service and guidance, pay thousands to the market in unnecessarily painful lessons, or at the hands of brokerage limitations. For instance, discount brokerage firms typically offer fewer products and have much less lenient margin policies and the risk management clerks tend to have heavy hands. I've witnessed occasions in which the positions of short option traders were liquidated despite a lack of danger in losing more than what was on deposit, or even triggering a margin call. The risk management department simply decided that it wasn't worth the commission revenue generated by the client to even entertain the idea of allowing the positions to play out due to temporarily high volatility.


I cannot necessarily provide nominal figures as to what is a "fair" commission rate because frankly, it should depend on the level of service provided, the size of the trading account and volume. That said, beware of firms that offer blanket commission rates because there is no such thing as one fits all when it comes to brokerage. After all, you wouldn't want to be involved with an insurance company that offers flat rates because it would entail low risk clients subsidizing higher risk clients...and brokerage services are no different.


What I can tell you is that being privy to an experienced brokerage staff can be effective in shortening the learning curve for young traders. I argue that trading with a competent brokerage that offers quality service, market research and support can do wonders in helping the bottom lines of inexperienced traders. In other words, commission (at least to a reasonable point) should be looked at as an investment rather than a cost. If you are saving money in commission by trading with a discount firm, but are consistently losing money, then you aren't doing yourself any favors.


Taking a step back to look at things with logic, a single unit move in most futures markets typically far outweigh a few dollars in commission. Specifically, one tick in Treasury futures is equal to $31.25, one penny in grains and silver is equal to $50, 1 handle in the e-mini S&P is $50. Do you really think paying a dollar or two more in commission to be trading with a quality firm will be the determining factor in your success? If the brokerage saves you one tick in your entry via quality research, support, or a shortened learning curve you are already ahead of the game!

 

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