- 1997: Volume 6, No. 5 Know Your Broker!

The expansion of the equity markets over the last decade, combined with an incredible number of investment vehicles, has created both opportunity and confusion for investors. Deciding how to participate, either through professional assistance and management or actively trading one's own account is an individual choice.

A Trader's Responsibility

It is up to each individual to carefully weigh the risks and potential of any investment. Careful consideration may help identify opportunities that most closely match an individual's risk profile, experience level, financial capability, commitment and personality.

People tend to go with what is most familiar to them. Naturally, this leads them to common stocks, mutual funds and bonds. These are, for the most part, stable, liquid, well-understood, available and widely covered by the financial media.

On the other hand, the international financial and commodity futures and options markets are traditionally less stable, occasionally illiquid, less understood, more risky and not as widely covered by the financial media. Because of high leverage and unique influences, trading futures and futures options are among the highest risk capital sectors.

Plain or Fancy?

The confluence of knowledge, need, fear and greed has attracted both the most sophisticated and simplest of trading strategies and personalities. Those who opt for a disciplined, practical and affordable methodology in keeping with their financial and emotional well-being have greater chances for long-term survival and success.

Trading these markets can be an emotional roller coaster. Small price movements using big leverage can cause equity fluctuations that require emotional control and rational thought that is at times difficult to maintain. Time commitment can be much greater than intended or expected. Understanding the minimum financial and emotional requirements to have a fair opportunity for success is absolutely necessary.

Transaction Costs

It has been said and rumored that the best traders in the world are probably wrong six times out of 10. Think about what that can mean to the equity in an account. Transaction costs should be watched carefully. While this is true for a broad range of investment vehicles and opportunities, it is particularly important in active trading accounts. No transaction cost seems too high when you are winning. Conversely, no cost is too low when you are losing. There is a reasonable middle, relative to your intentions and expectations.

Market Access

Market access is very important to every trader. When a signal is given or a decision is made the ability to execute the trade or plan becomes paramount. Even the most liquid of free markets has a bid and ask spread that, at times, moves away from a price very quickly. Slippage (defined as the difference between the price you saw and wanted and the price you got) on market orders can at times be positive for a trader, but don't count on it any more often than you see your fairy godmother. A few minutes difference on the same order in the same market on the same day can result in dramatically different prices.

The leverage available in trading futures and options is a compelling attraction for many sophisticated investors. The possibility of making or losing lots of money, using only a little money, exists whenever the market is open. Highly complex and sophisticated ideas are being developed, tried, implemented and either enhanced or discarded by both exchanges and traders every day. The nature and complexity of these markets makes the choice of broker and brokerage firm important.

A Matter of Trust

Consider first the characteristics you look for in someone you trust. Your banker, your stockbroker and your doctor are all usually unrelated and trusted with confidential information about you. Interview prospective brokers and firms. Ask how the firm is regarded in the business. Is your money safe? How long has the firm been in business? How long has the broker been in business?

Allow for Murphy's Law

You should certainly find a firm that fits your needs rather than you fitting theirs. With the onset of electronic trading many people may believe they can set up shop, open an account and trade away. Has your computer worked perfectly since the day you got it? Ever had your phone go dead? Lost the electricity? Ever made a mistake? Talk with the prospective broker about your intentions, your experience, your motivation, your financial condition, your risk tolerance and your availability.

Order Routing

Ask how your order is routed for execution. Talking is usually faster than typing. The evolution of technology has given wonderful benefits, but its reliability is still questionable. Is there anyone who will catch you if you make a mistake? Can they accept complex orders? How fast can you get an order filled and reported? Trading active markets, using three to five percent leverage, can make minutes seem like an eternity.

Think Globally

How well are you covered while involved in trading? Just because you go to bed in one time zone doesn't mean the world stops. Unexpected events have at times created market upheavals that can be wildly profitable or financially terminal to a trader. Does the firm have a 24-hour desk committed to helping you when needed?

What Will It Cost?

Costs are commonly superseded by issues of trust, experience and long-term client commitment but nonetheless a real concern. What will it cost you to invest in a managed account or fund? What will it cost to open a trading account? Is there any charge if you close your account? What are the transaction costs? Are there any other fees or charges?

Although price is a primary consideration it is not always the most important in a brokerage relationship. The broker is going to work for you and provide you with service, information and access. The broker will be your conduit to the market, familiar with your intentions and needs, and capable of resolving a mistake or fixing a problem. With a little effort you can find a broker qualified to earn your trust.

Check Your Broker Out

Do some digging before you open an account. Ask about the history of the firm and the individual brokers. Ask for referrals and references. Talk to several brokers before opening an account. Check with the National Association of Securities Dealers and the National Futures Association with questions about a firm or its individual brokers. Many active traders talk with their brokers more often than friends and family so you had better get along.

Many firms invest heavily in technology and my firm is no different. But don't make a decision based on technology alone. The trader/broker relationship has traditionally been based upon integrity, trust and confidence. Faster modems and bigger servers have not changed those foundations.

You're In Charge

Above all, remember that it is your money that will be at risk. With every opportunity in the futures market there is a corresponding risk of loss. Don't expect miracles from your broker. If a broker were a great trader, he or she would be on a yacht in the Caribbean and probably not talking to you. You are the one with the time, the energy, the money and the methodology to be a great trader. A great broker can provide fast and professional market access, timely information, accurate prices and, as needed, access to enhance the opportunity of a client's success.

The overriding responsibility traditionally given brokers is "Know your customer." My advice for a futures or options client is "Know you broker." Your long-term opportunity may ultimately depend on a long-term relationship built on trust and confidence.

John Welsh is senior vice president and heads the Private Client Group at Rand Financial Services, a Chicago-based global futures brokerage. He can be reached via e-mail at jwelsh@rand-usa.com.