May I take your order?

March 31, 2009 07:00 PM

Placing a trade isn't like ordering pizza, and there's more to finding a broker than calling the nearest FCM. Choosing the right broker and learning the language of trading are crucial to building a solid broker-client relationship and a solid trading account.

"The broker-customer relationship is a pretty intimate one, when you think about it. Unfortunately, people tend to approach it like sheep going to slaughter - they just call up the brokerage, and whoever they get on the phone is it," says Phil Tiger, vice president-futures at Smith Barney. "Most people care about the firm they're with - not as many are as conscientious about picking the person who places the actual trade," he says.

A broker-client relationship is just that, a relationship, and it should be founded on mutual trust. "People must remember that it's a partnership," says Melinda Schramm, chairman of the National Introducing Brokers Association. "If one doesn't do well, the other doesn't do well."

Unfortunately, when "shopping" for a broker, many traders don't think beyond fast fills and fees. If you really want to find a broker you'll be comfortable with, you have to dig a little deeper.

First, when questioning prospective brokers, establish their background and market knowledge. Age and experience are critical factors, says Tiger, "because the market can teach you caution." Though measuring experience can be subjective, he says it's important to work with a broker who has been in the business for five years or longer. "If [they] can survive at least five years, you know [they've] learned some things."

Also, a quick phone call to the National Futures Association (312-781-1300) will tell you if the broker is registered and if there is any pending litigation against him.

Try to determine the breadth of the broker's experience, as well: Does he appear knowledgeable in financial markets as well as grains? Is she comfortable trading spreads? If you plan to trade a variety of markets, make sure your broker is familiar with (and a clearing member of, or has access to) multiple exchanges and markets, at home and abroad. If you want to specialize, make sure your broker knows your market's "personality" - its seasonal tendencies, volume and open interest, volatility, etc.

"You need to know whether they really understand the futures business or whether they're just looking for an order," Schramm says.

She also recommends asking for a financial statement. Because it's the financial worthiness of the brokerage that guarantees your account, you need to know how well capitalized the firm is: "If a broker is reluctant to give you written proof of profits, they may not be telling you the complete truth," Schramm warns.

Service with a smile
The level of service you get with your broker (and your fees) will vary depending on whether you opt for a discount or full-service house. Discount brokers execute the orders you initiate, generally offering opinions only when asked. Traders who use discount houses tend to utilize their own trading system and methods, have a source for real-time quotes and subscribe to charting and news services.

A full-service house offers more customized order entry and personalized service. Unlike a discount broker, full-service brokers will call you with trade recommendations and help with your overall investment portfolio. They also will supply you with relevant fundamental and technical information in the form of government reports, market-moving news items, chart analysis, advisory newsletters, 800 numbers, etc.

Occasionally, the line between discount and full-service grays. For example, for an extra charge, some discount houses offer a "hybrid" service in which clients are assigned to one associated person who will discuss market outlook based on a selection of chart patterns and reports. Discount brokerages today also offer hotlines, on-line quote services and market information - but the final trade decision still is yours.

"Service" encompasses everything from back-office procedures to office hours. If something is important to you, don't be afraid to ask. For example:

Are brokers available to place trades 24 hours a day?
How many desks does the firm have on the floor, and where are they located (i.e., close to the pit)?
What does a daily statement look like, and how easy is it to read?
If I get a margin call, will the firm only accept wire transfers?
What is the average reporting time for fills in the market I want to trade? (It may take longer to get an order filled in the cocoa market than in Eurodollars.)

Also, ask how much help you get when calling in orders (see "How to place an order"). The level of attention will again depend on the type of broker. However, market demand continually sets new standards. For example, because over half their business can stem from new traders, some larger discount brokerages now have desks set up with clerks who will take more time to explain how to place an order correctly.

Regardless of the type of broker you use, high-end service means higher costs. Discount and full-service fees generally are based on which markets you trade (oats are cheaper than metals, for example), on which exchanges you trade (New York markets can be more expensive than Chicago), and the amount of business you generate (high-volume accounts get price breaks). However, "the broker you choose should show some concern about your account, regardless of its size," says Lind-Waldock broker Carol Dannenhauer.

Also, less overhead allows discount brokerages to charge less, anywhere from $20 to $35 per round turn, though hybrid or specialized services will add to your bill. The more personalized attention provided by full-service brokers naturally costs extra: $75 or more per round turn.

Trading styles
If you use a full-service house and choose to let a broker make trading decisions for you on a discretionary basis, be familiar with his or her methods: whether he is a long- or short-term trader, what kind of technical and fundamental indicators he uses, and, if he has his own trading system, do you have to use it?

"Most brokers are very happy to have customers who are knowledgeable and have their own trading methods," Schramm says. "But brokers who have their own system may only feel comfortable making money for you if they can use it."

No matter whose system you use, be sure you both have a clear trading plan in place. You should both know how much money you're willing to risk on each trade, your profit objectives, whether you prefer to avoid highly illiquid or volatile markets, and what plan you have for taking losses.

Above all, listen carefully to the broker during your initial conversations. If he merely touts his profitability and never talks realistically about the risks involved in trading futures, consider it a warning flag. "If all he says is 'profits, profits, profits,' he's only telling you one side of the story," Schramm says.

It's equally important to hear the broker ask you questions about your trading goals and what you expect of him. "The brokers check out the customers, as well," says Bill Byers, director of futures research with Bear Stearns & Co. "A lot of times [customers] have the jargon down, but don't know what it means. I'm going to make sure the individual is mentally suited to trading and has a game plan - the last thing I want to do is take a guy's money when it's all he has."

About the Author