Types of Futures Brokers
Futures brokers fall into one of the three categories. Depending on the category they are classified under, you can start to sense the level of service including fees and markets that you can access start to change. Futures brokers are either:
Full-service futures brokers
Discount futures brokers
Online futures trading brokerages
A full-service futures broker as the name suggests is like an agency that becomes your eyes and ears of the market. A full-service futures brokerage typically views your investment as a new business. A full-service future broker obviously comes at a higher cost of entry and therefore for the retail futures day trader this is probably out of reach. This type of a futures brokerage model makes it ideal for those who have money to invest but find it too difficult to trade for themselves. A full-service futures brokerage is a mix between a managed futures trading manager and a regular futures broker.
A discount futures broker is a cost-effective way to trade futures, most likely via electronic trading. The word discount usually means low service fees, low minimum deposits, low exchange fees. In short, this is a relatively hands-off approach (you are on your own for the most part), but assistance via. phone, email and online chat is there if you need it.
Online futures trading brokerage is mostly a blend of full-service futures broker and a discount futures broker. This is the most common type of online futures brokerages that you see and will very likely end up at one of these. The fees are still competitive (although not as low as discount futures brokers) and in most cases you also get full support in terms of trade execution and charting and analysis tools.
Margin, Leverage and Fees
We know that the margin requirements are usually set by the Futures exchange. However, futures brokerages can also set their own leverage and margin. This is even more evident when you look at day trading margin and standard margins. While futures brokerages compete for your business by having low day trading margins, the moment you decide to hold your position overnight, the futures brokerages are required to post the minimum margin same as that of the exchange.
In May 2019, the margin requirements for the e-mini S&P 500 (ES) contracts was $6,300.00 USD per contract. Meaning you must have a minimum of $6,300 USD per contract you currently hold, deposited in your trading account to hold the position outside of day trading hours. This is called the maintenance margin. The commodity exchanges adjust margin requirements as the value of futures contracts rise and fall or in the case of extreme volatility. If you can’t post the maintenance margin to hold contracts during the overnight session, your broker retains the right to liquidate your positions.
For the most part though, day trading margins are where most of the action happens as you can come across futures brokerages specifically targeting potential clients with reduced day trading margins and lower commissions. On average, day trading margins on the more popular e-mini contracts such as the S&P500 (ES), Dow Jones, Nasdaq or the Russell can be as low as $400 - $500 USD per contract traded.
This tends to increase the leverage on the day trading accounts and increases the risks on both the futures broker as well as yourself as a trader. Managing higher leverage typically is a result of managing risk from the futures brokerage and the trader to certain extent. Leverage, while can help your day trading can equally magnify the risks of losses as well.
Leverage is the grease that makes big profits on small investments possible: It allows you to control tens of thousands of dollar’s worth of a commodity with a deposit of a few thousand dollars. The amount of leverage involved with commodity futures depends on the type and size of the contract. To calculate the leverage of a commodity future, you must divide the value of the contract by the margin requirements.
Therefore, while day trading margins might seem attractive especially when it is lower, the same low margin requirements for contracts can also turn out to be riskier especially when you stop following your risk management rules or when the markets are subject to surprising bouts of uncertainty.
Besides the margin and leverage requirements, futures traders also need to focus on the fees. There can be a lot of fees, which although might look cheaper in isolation can add up to a significant amount over time. A futures brokerage typically charges fees ranging from account maintenance fee, to platform fee, data fee, and other brokerage fees. As a futures day trader it is essential to bear in mind the different fees that are charged. Again, there is no straight forward answer to this because a professional futures day trader wouldn't mind paying higher fees for better access to the markets while for a futures day trader, low margins and trading fees are a better option. However, if you are starting out trading the e-mini S&P (ES), a $4.00 to $5.00 all-in round trip per contract is a reasonable cost to expect.
Regulation, Age of Business
An important factor to consider when choosing a futures broker is first and foremost to identify if the broker is licensed by a respected financial oversight body. Most futures brokerages in the U.S. are regulated by the National Futures Association (NFA). You can always head out to their website at http://www.nfa.futures.org/ and look for a potential futures brokerage that you want to trade with.
Being regulated by a financial watchdog ensures that the futures brokerage adheres to various standard business practices. Typically to buy or sell a futures contract you need to buy membership on the trading exchange. The futures brokerage typically plugs this requirement and acts a communication link between your orders and the exchange. As per the U.S. lower, futures brokers do not have any authority to take the customer funds and hold them in deposit. Therefore, futures brokers typically team up with an FMC or a Futures Commission Merchant who is responsible to legally hold customer funds on a margin account and clear the trades. An FCM typically does all the back-end tasks such as recording trades, daily mark-to-market on your futures account and sending summaries and trade confirmations.
FCM's must be licensed by the Commodity Futures Trading Commission, which also regulates alongside the NFA which conducts regular audits among its members which include Futures Commission merchants, introducing brokers, Commodity trading advisors, commodity pool operators and so on.
When choosing a futures brokerage, it is also important to know how long the futures broker has been in business. In most cases, futures brokerages are typically well-established companies that have been in operation for some time. However, the recent rise of electronic trading has given room for many retail electronic futures brokerages that are relatively new but at the same time more technologically savvy.
No matter what kind of a futures brokerage that you choose, the bottom line remains the same. Ensure that the futures broker is well regulated and has an established business to ensure validity of their business.
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Before you get started trading futures you need to choose a broker. Without a broker you cannot trade futures, so choosing a futures broker is an important decision. Without having the right platform to support you as a trader and offering you the right tools to make an informed decision, no amount of trading strategy or expertise will be able to help you if the basics not in place.
If you are an independent futures day trader having the right futures brokerage can go a long way in servicing and supporting your trading needs.
Execution and Technology
Execution of orders plays an important role and can be one of the few things that can be the difference between a winning and a losing trade. While most day traders tend to focus on fees, margin and leverage (which are important and discussed shortly), execution of the trades doesn’t rank that high.
No matter how good your trading may be, slippage (not getting the bid or ask fill price you wanted) can eat away into your profits which over time can be a significant. In general, however, I have rarely witnessed slippage in the ES, but on occasion it does happen.
Depending on the type of futures brokerage that you choose, some might also offer an inbuilt charting and trading platform as well, which can make a world of difference for some futures traders.