Key Questions to Ask Your Commodity Trading Advisors (CTAs) and Brokers. Reasons to Understand your Brokerage firm’s Margin Policy for Commodity Futures Trading.

February 28, 2011 by · 1 Comment
Filed under: Investment 

Key Questions to Ask Your Potential Broker
Always ask a lot of questions—remember, there’s no such thing as a stupid question. Often, people end up blinded by profit potential without really understanding what they’re getting into or whom they’re dealing with. Step back and take a breath. Be patient and quiz the firm that is selling commodities. See whether they know their stuff. Never go with a wishy-washy or uncertain broker who won’t answer questions such as these directly and fully:
 Are they registered with the CFTC, NFA, or any other regulatory agency?
 Do they conduct transactions to be executed through a regulated commodity exchange?
 Does the firm have literature or written materials explaining the transactions or a risk disclosure statement?
 What is their fee rate and margin policy?
 How long has the particular broker been in the business and what is his or her NFA ID number?
 How long has the firm been in business and who are its principals and officers?
If anything seems fishy or not quite right, then it’s probably better to move along to the next candidate. There are hundreds, if not thousands, of highly qualified commodity trading advisors (CTAs) and brokers, so shop around before you make that important decision that could change your life.

The other most important factor is how well you like this broker’s personality. Hiring a broker and bringing him or her into your network is a little like getting married. Be sure you’re going to enjoy talking to and interacting with this person and that you trust and respect the person. After all, your broker is going to be your lifeline to the trading pit; you want someone on your side who will look out for you and alert you to profit opportunities on a regular basis. A good broker also can advise you on which markets are thinly traded, when you should use stop orders, and similar issues.
Which brings me to another major mistake traders can make early on: trading in illiquid, or “thin,” markets. This can be very risky. A thinly traded market is one in which there are not a lot of participants. This type of market offers little liquidity and is trickier to move in and out of, making it more difficult to offset a position. So it’s better to avoid such markets unless you’re absolutely sure you have the skill and experience to handle them. Illiquid markets that come to mind are the ultraprecious metals like platinum and palladium, natural gas, lumber, and cattle, to name just a few. Just because a market is thinly traded doesn’t mean you can’t make money; in fact, quite the opposite is true. It’s just that you will have to assume much greater risk tolerance, swallow a lot more Rolaids, and get a lot less sleep at night.
While we’re speaking of thinly traded markets, another person I hope you never have to get to know too well is the margin clerk.

There’s a Reason for Margin
Margin. Few words conjure up more fear in commodity futures than that one (except maybe tax audit). But in all honesty, margin is a good thing. Unlike in the stock market, margin in commodity futures acts as a performance bond, ensuring that a trader will meet his or her obligations. When you initiate a commodity futures position, you usually only put up an initial deposit of about less than 10 percent of the value of the position; you then must maintain a specific amount in your trading account while your position is open. Your initial margin requirement is relatively small compared to the value of the position, and the resulting leverage can lead to quick and substantial profits (or losses). Keep in mind, though, that it’s possible to lose more than the amount of money you’ve deposited. A good rule of thumb is to use only funds that you can afford to lose without affecting your ability to pay the mortgage and eat regularly. Furthermore, devote only a part of these funds to any one trade.
If the market moves against you, you run the risk of experiencing the dreaded margin call. Enter the margin clerk, who has the unenviable task of informing clients that a position has gone against them and that they must replenish their margin accounts immediately. When a client receives a margin call, the margin clerk will give the client a certain period of time to meet the obligation or have the position(s) liquidated. If possible, get to know the margin clerk at your brokerage firm, preferably before you experience a margin call. Don’t get me wrong; it’s not going to get you any special treatment or extra leeway, but it will give you a relationship ahead of time, and the margin clerk will be more keen to give you time to meet the call and be fair, rather than treating you as just another account number.
Brokerage firms have one goal: They want zero risk. Know your firm’s margin policy thoroughly and be sure to meet any margin calls should they arise. The best practice is to use strict stop order discipline to avoid getting a margin call in the first place. A skilled, full-service broker who is worth his or her salt can teach you this, and while the commissions may be a little higher, the knowledge you gain can pay for itself a hundred times over.

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