From the September 01, 2006 issue of Futures Magazine • Subscribe!

The real price of discount trading

All it takes is a quick flip to the back of this magazine to confirm that the cost of trading is plummeting. Consolidation in the brokerage industry and the rise of internet trading has created an environment of intense competition, pushing trading costs lower and lower.

Some futures brokerage firms are advertising fees of less than $2 for futures trading. But in trading, as with everything, there remains a wide range of possible fee structures and service levels for the retail trader and you have to know what questions to ask and to read the fine print to find what you need, get what you want and not overpay. But in trying to achieve that goal, it’s easy to go too far in the other direction, paying next to nothing and getting exactly what you paid for.

“Back in the old days, the broker would take discretion and do all the trading and get input from the client about what the client wanted to trade and how much,” says Joe Krutsinger, a registered information CTA and president of the trading system design firm that bears his name. “He really did do everything and that was all included in the fee. Nowadays we’ve got people who are trying to get everything for free. But free can be the most expensive thing you ever buy.”

Fix Prix, `à la carte & automat

When shopping for a futures broker, the two most important things to know are: what you are paying for and what you are getting. At a minimum, a trader will pay an exchange transaction fee, a National Futures Association (NFA) fee, which is pennies, a clearing fee and a commission. And while a firm may advertise extremely low fees, that price may not apply to all exchanges or all contracts. Exchange transaction fees vary from exchange to exchange, from contract to contract and from pit to pit.

Electronic exchanges tend to be less expensive to trade in than predominantly open-outcry exchanges, and exchange transaction fees are not negotiable at the retail level. However, unless the broker is marking it up, the exchange transaction fees should be consistent from broker to broker for a specific contract on a specific exchange. Exchange transaction fees should be listed as a line item on your customer agreement and are easily verified by checking the exchange’s Web site.

With this in mind, it is important to know if the quoted rate is all inclusive or à la carte. Additional charges can include electronic transaction fees, verbal order fees and mysterious ‘brokerage fees,’ above stated commissions.

“Everybody has some price they advertise, but when you go to buy it, you’ve got to pay more to spray the undercarriage,” laughs Todd M. Lang, vice president of Field Financial Group, likening the process of shopping for a broker to shopping for a car. For self-sufficient traders, his firm quotes a $19 flat rate per round turn for verbal orders, a flat rate of $8.98 per side for electronic orders and a flat rate of $4.98 per side for e-minis. Those rates include exchange transaction fees, commissions, clearing fees, the NFA fee and an electronic transaction fee.

But this approach isn’t for everyone. Andrew L. Gadzinski, founder and president of SuperFutures.com says one sign of a good brokerage is that it will offer different rates for each pit it trades in. “Get a good S&P rate, a good e-mini rate and make sure you are not paying New York prices for trading in Chicago,” he says. His firm offers electronic trading for as little as $1.89 per contract, per side and trading in open outcry pits, such as those in New York for $8.25 per contract, per side, but those costs can fluctuate based on the size of your account, the volume you trade, your experience, platform and the contract you want to trade.

Both pricing models are legitimate and offer certain advantages to different types of traders. All inclusive prices eliminate the opportunity for ugly surprises, and some traders are willing to pay a little bit extra for that; while à la carte pricing allows for additional savings at the expense of more vigorous cost comparison.

But make certain you are making a fair comparison. In futures trading, you have to submit an order to both enter and exit a trade; a completed entry and exit is known as ‘round turn.’ And not every firm quotes fees on a round turn basis. Many will quote rates as ‘per side,’ which leaves you having to double the quoted price to accurately compare them.

Other ways that discount brokers attract traders is by advertising lower margins and introductory rates. While lower margins do lower trading costs and can be a real benefit to some traders, they also can result in a quick margin call or cause you to unexpectedly get blown out of a trade.

Commissions

For a broker to have any chance of quoting you a reasonable rate and of meeting your expectations, he has to understand your requirements. So be ready to discuss what you want to trade, how frequently you want to trade and how you want to place your orders. In addition to giving the broker the information he needs to quote you a meaningful rate, you are building a rapport, which can only help you in negotiating a better price. “How much commission am I going to pay? That’s the last question they should ask,” says Ronald R. Goodis, director of retail trading at Equidex Brokerage Group Inc.

“For people to really get what they need, they need to explain exactly what they want to do. Maybe I’m not your guy. I may not be able to get you what you need. But you will never know until you ask.”

As a trader becomes more experienced, more confident and places his own orders, that trader can expect to pay less because self sufficient traders are less demanding of the broker and the firm’s resources.

“I’ve seen commissions go from $150 per round turn to $7.50,” Goodis says. But with the discounted rates comes minimal services, and the trader has to be almost entirely self-sufficient to enjoy discounted rates. “The novice trader who rushes in and thinks he is going to trade at a discounted rate is going to get killed.”

While Equidex also offers discount trading, the full service fee is $60, and at that price, Goodis says the client has a professional broker to answer the phone and to discuss markets, strategies and trading ideas.

going it alone

Inexpensive electronic access has revolutionized the futures markets attracting more traders, increasing liquidity and has opening previously inaccessible global markets. Those are all positives, but the drawback is that with trading costs so low, retail traders need to fend for themselves. They are responsible for their own education on trade types, chart patterns, research and portfolio and risk management. And whereas in the past a new trader could expect to learn from their broker, experience is the new teacher and the Internet is the new classroom. The hidden cost is personal responsibility for the services that have historically differentiated brokerage firms.

While electronic trading allows everyone to see the bid and the offer and the market depth, traders are now freer than ever to make their own mistakes, mistakes that a broker would typically catch and correct. “Most people think the most important cost is the commission,” says Rick Thachuk, president of commodity trading advisor World Link Futures Inc. “People don’t think about human error,” and those errors can be costly.

Thachuk says many traders will unknowingly enter the wrong order, and the trading platform accepts the order because while it’s not a good trade, it’s not technically an incorrect order. For example, if a market is trading in a range between 70 and 100, many new traders would place a limit order, get filled and receive confirmation that he bought at the market price within seconds. But a better trade would have been to use a stop order to trade a breakout from the range.

Another common mistake is incorrectly calculating margin requirements or the risk before placing a trade. “Before you put on the trade, know what this costs per contract, how many contracts and how far it can move against you before you are in risk of getting a margin call,” Thachuk says. Another typical rookie mistake is misplacing a decimal in the calculations, thinking a five point move can wipe the trader out, when in reality it’s half of a point that will. “If they don’t want to invest in their education, they should invest in a full service broker,” he adds.

Krutsinger says it’s buyer beware. “The problem [with self service] is that you are on your own,” he says. “You are your own broker. It’s a very good deal if you are professional enough to be your own broker. You better know what you are doing and watch that all day long, because if the data goes out and you’re stuck in something, nobody is going to be watching that for you like a professional broker.”

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