One of the first pieces of advice new traders receive is to treat trading like a business. And, just like any business, trading has some costs associated with it that you need to be aware of regarding initial capital requirements, hardware recommendations and ongoing commission structures.
Over the last 10 years, more retail clients have been introduced to the futures industry. One reason for this business growth has been the exchanges promoting the industry to retail traders, according to Nicole Sherrod, managing director of the trader group at TD Ameritrade. “Historically, if you look back 10-20 years, the futures business was really targeted at sophisticated, professional traders. Now, more and more retail investors have been getting into the business of trading futures,” she says.
As you are getting started trading futures, one of the most important things to consider is your inital bankroll. Like many things, it is a balancing act — start too low and you put incredible pressure to succeed on yourself, but start too high and you might threaten other areas of your financial well-being.
Dave Gompert, senior market strategist at Trade Monster, recommends new futures traders begin with at least $5,000-$10,000, but that amount should not be more than 5% to 10% of your liquid net worth. Sherrod says many firms require a $10,000 minimum initial deposit.
Gompert says that if you start with a smaller amount, it puts you in the position of having to be right pretty much immediately. “While you could start with a smaller amount as a new trader, I don’t know that that is going to turn you into an old trader. It could get challenging because it’s essentially like telling a rookie baseball player, ‘You’d better go 4-4 in your first game, or we’re sending you back down to the minors,’” he says.
The primary reason for needing a sizeable bankroll to begin with is because futures contracts trade using margin and leverage. Gompert says that futures contracts average about 10-1 in leverage, meaning you typically must put up 10% of the value of the contract as margin. “So, even small movements in the market are multiplied by 10 in terms of hits to your capital or gains. Everyone loves them when there are gains, but losses can pile up really quickly,” he says. “If you don’t have much to start with, you could be out of the game quickly.”
In addition to ensuring you are capitalized well enough to begin trading, it also is important to have adequate access to technology.
The vast majority of trading is done electronically, so you need to make sure your computer system can handle your trading platform without slowing down or crashing. Also, ensure that your Internet connection is fast enough to receive up-to-date data feeds and to get your orders to the exchanges in a reasonable amount of time to avoid slippage.
This does not mean you need a cutting edge system, but it does need to be current, Sherrod says. “You want a fast system. You want to make sure that the operating system is fairly current. Speed is a really big thing in the futures market,” she says. “We encourage traders to consider it an investment to make sure their hardware is up to date.”
In addition to your technology, consider a prospective broker’s technology when you are shopping around. Does it offer a competitive front-end trading platform to its clients, or will you need to license one from elsewhere? Does it have a mobile app that allows you to monitor and make changes to positions on the go?
Once you’ve made the initial investment in technology and your starting bankroll, most of the day-to-day costs of trading will come from the commissions your broker charges. Brokers offer clients a service – access to the markets – and charge a fee for that service in the form of commissions. Additionally, brokers also collect fees charged by the exchanges and regulators.
Depending on your broker, commissions can be quoted in terms of per-contract, per-side or as a round-turn. A round-turn consists of both an entry and exit of a contract to end with no net position. Gompert says most traders will be quoted what their commissions will be round-turn, but on their statement see it charged as per-side (see “Scaling in,” below).
In addition to exchange and regulator fees, Sherrod says that some brokers also add fees for technology or data feed usage, or will set minimum trading requirements where you have to make so many trades on a quarterly basis to have access to the streaming technology. Check your broker agreement to see if these apply to you.
Beyond the commission brokers charge for access to the markets, they also pass along the fees assessed by the exchanges and regulators.
Exchanges make their money by charging a fee on each product traded. “In terms of exchange fees, in futures they are charged on every trade and they are charged per-contract, per-side. So when you enter a position, you’re charged, and when you exit a position, you’re charged,” Gompert says.
These fees are set by the exchanges, and brokers pass them along to the trader. “You can find all of those fees on the exchange websites, but it varies depending if you are trading the E-mini S&P 500 or a commodity-based product. Firms do make an effort to be as transparent as they can in respect to what those fees are,” Sherrod says.
Finally, traders also will see a regulator fee on trades. In futures, that fee goes toward funding the National Futures Association (NFA), while in securities it funds the Securities and Exchange Commission (SEC). The NFA charges a fee on both the purchase and sale of futures contracts, while the SEC only charges a fee on the sale of securities. In both cases, the fee goes to keeping the regulator, or self-regulatory organization in the case of the NFA, running.
The trading industry continues to change, particularly with the passage of the Dodd-Frank Act in 2011. As rules are finalized, many brokers expect to see their operating costs increase, particularly in regard to compliance costs.
“It’s a little bit too early to talk directly [about] what impact rules may have on the firms,” Sherrod says. “With some of Dodd-Frank, it could be that there are additional reporting requirements, there could be additional documentation of policies and procedures, some firms may have increased technology expenses to go with as well. Those three things may mean increased costs, but most of those are at the headcount level within firms, and [don’t] necessarily fall as a burden to the end-client.”
Gompert agrees with that assessment, but expects traders to see their costs increase in indirect ways. “The hardest thing to do in this business is raise commissions. The costs at brokerage firms are definitely going up because of increased reporting and monitoring requirements, so what we may see happen for both new and experienced traders is brokers will be less likely to negotiate better deals for activity or volume,” he says. “Typically, a guy [who] trades a lot of contracts frequently can negotiate a better commission rate for himself. We’re going to see those negotiations stall a little because broker fees have gone up.”
Where Gompert does expect to see costs rise as a result, at least allegedly, of new regulation is at the exchange level (see “Exchanges and regulators let traders down in 2013,”).
Both Sherrod and Gompert encourage traders to look at the services a broker offers in addition to the commission costs. Education is important, and having a broker that will help you through your first few trades can save you money by avoiding mistakes. “The savings you get on commissions may be eclipsed completely by the losses you take on mistakes,” Gompert says. “Having a relationship with an experienced, licensed professional who can coach you through the early phases of trading, that can end up saving you thousands of dollars in costly mistakes.”