Futures trading definitely is a world unto itself. For a new trader getting started, the list of things to learn can seem endless. Naturally, it seems the first place new traders go to get answers is their new broker. After all, they were so nice when setting up your account.
To help alleviate the sheer number of calls, we spoke with a couple brokers to learn what some of the most common questions new traders have for them. Here are six of the most common, and a brief answer.
1. “What is margin?”
Unlike securities where investors must purchase shares at full value, the futures industry allows traders to employ leverage. This means a trader can control a position much larger than his bank account otherwise would allow. To do this, though, he must meet an initial margin requirement and then keep his account above the maintenance margin requirement.
Donna Heidkamp, president at RJO Futures, explains that margin requirements are set at the exchange level and are standard industry-wide. She recommends that traders maintain an account balance two to three times higher than the maintenance requirement to avoid a margin call. “If your account drops below the maintenance margin requirements set by the exchange, then you would be required to either add funds back up to the initial margin requirement or liquidate some or all of your position,” she says.
Additionally, although margins are standard across the industry, they can be changed by the exchanges. “[Margin] can change pretty radically,” says Steve Sanders, senior vice president of marketing at Interactive Brokers. “If there’s been a lot of volatility in oil over the last week, you can expect there to be an increase in oil margin.”
2. “Why are there expiration dates?/What is rollover?”
Futures are contracts with set time periods. Unlike securities in which you just buy what currently is available, futures allow you to trade products that may not even be grown, yet. As such, each contract has a number of dates associated with it, set by the exchanges. In addition to expiration dates, each contract also has a first position day, last trade day and, if applicable, a delivery day.
In most cases, the contract with the earliest expiration, or the front contract, is the most actively traded. But, that does not mean you can only trade the front contract. If you choose, and if there is available liquidity, you could take a position in a contract months or even years from expiration.
Because a contract has an expiration date, it is important to make sure you exit the position prior to the last trading day, unless you want to take physical delivery. To do that, you must “rollover” your position. This means you have to buy or sell enough contracts in the current month to make your position flat, and then reestablish your position in the next contract month. Some brokers offer special rollover orders what will take care of this for you.
3. “What are the market hours?”
Sanders says he is surprised by this one because all this information is available on the exchanges’ websites and on most brokers’ websites, but says apparently some people would just rather call up and ask someone directly.
Since trading has moved to mostly electronic, many markets are open 24 hours a day, but you still need to understand what you are trading. Beyond know what the actual product is, take time to read the contract specs, including the hours the market is open.
All contract specifications, including market hours, can be found on the products page on each exchange’s website. Most brokers also make this information easy to find on their websites.
4. “Why am I not getting the prices I want?”
For new traders, it can be bewildering when you don’t get the order price you asked for. Say “hello” to slippage. “When markets are declining quickly, there are a lot of people believe that if they put in stop orders, they have protected themselves,” Sanders says. “Unfortunately, the markets don’t work that way and everybody is exposed to slippage. There’s no getting away from it.”
Although order books typically are deep enough to ensure you get the price you ask for, if volatility is on the rise that liquidity can dry up. The result often is that you do not get the price you initially asked for, especially if price is moving quickly. While slippage can work in your favor, it’s really best to expect it to go the other way.
5. “How do you charge commissions?”
For the privilege of using brokers’ access to the market, they charge a commission on every trade that is placed through them. While every broker likely has a slightly different commission structure, there are some common things to watch for.
First, find out how often a broker charges commissions. Do they charge per side or round trade? If it is per side, that means they charge a portion of the commission on both the entry and exit orders.
In addition to the commissions a brokers charge, they also collect feels for the exchange and regulators, if applicable. Many brokers lump this all together in a “commission-plus” model where the fees are added to the broker’s commission.
6. “How do I know I’m working with a reputable firm?”
Over the last year, this has become one of the most important questions to ask any firm. Since MF Global declared bankruptcy on Oct. 31, 2011 and customer funds were discovered missing from PFGBest in July 2012, customers rightfully have begun to question the firms they do business with. Prior to MF Global, Sanders says, “People just thought that if there were losses, the broker just would cover it.” Turns out you have to know how they are going to cover losses, not using customer funds.
To protect yourself, Heidkamp recommends you do research on any broker you are looking at working with. Check to see if it has a financial integrity letter. Look at the firm’s history, do they have a number of complaints filed against them by regulators?
A couple resource include the National Futures Association’s Basic database, which tracks complaints and tells who a broker is associated with. Additionally, the Commodity Futures Trading Commission publishes monthly data regarding assets held by futures commission merchants. Of course, also check out Futures’ annual “Top 50 Brokers” feature every December.
It takes years to become a market master, but everybody has to start somewhere. But, a little research and asking the right questions of the right people can shorten that time.