Choosing a broker - reliability, commissions and margin requirements

Much of what I have to say is covered in this link and this link too. Even though both links pertain to forex brokers, much of the same criterion apply to choosing a futures broker.

I am based in Singapore, so additional considerations for me include "how much do they charge for wiring money?", and nowadays, "is my broker financially secure enough?", and perhaps whether they accept a base currency other than USD.

In choosing a futures broker, for me there are three primary considerations.

1. the broker's connection to the exchange must be reliable and fast
2. the commissions that I have to pay per roundturn must be competitive
3. the margin requirements should be low

The first requirement is a no-brainer. It is impossible to trade if you have no faith whether your orders are getting to the market or not.

The second requirement is a bit tricky. Roundturn commissions refer to the total cost per completed trade, i.e. the total fees (including exchange and miscellaneous fees) of entering and exiting the market. This is something that most people don't really pay heed to, especially when starting out, but arguably this is the most important thing to look at when choosing a broker. Why? Because commissions can eat into your profits, especially if you overtrade, and commissions scale up with your increased trading size.

For example: Suppose you are trading the CBOT corn contract, and you have a choice between two brokers. Broker A charges you a roundturn commission of $7 per contract, while Broker B charges you a roundturn commission of $6.50. The minimum price fluctuation ("tick value") of the contract is $12.50 per tick.

Suppose that you made $1,000 per contract from trading corn, which is 80 ticks. Suppose as well that you made this by making 1 tick per trade: therefore you got to the $1,000 by making 80 trades. With Broker A, your commissions will cost you $7 x 80 = $560, or a stunning 56% of your total profits. With Broker B, even though it is only $0.50 cheaper per round turn, your commissions will be $520, a full 4% less than with Broker A. If you can find a third broker Broker C to offer you commissions of $6.25 per round turn, under the same trading conditions your total commissions will be $500.

Bear in mind all this is per contract: if you scale up your size to trade in lots of 10+ contracts, your costs will have multiplied by 10.

Moral of the story: Undertrade, rather than overtrade, especially as a retail trader! And try to lower your commissions, as these are business costs that scale up with the size of your trading.

Tip: when you have been trading regularly for a while, call your broker to ask for a reduction in commissions.

The third requirement is about the margin requirements. Most people misunderstand the difference between margin in the stock market vs. futures margins. In the stock market, when you buy stocks on margin, you are basically borrowing money from the broker to buy/sell stocks.

In the futures and forex markets, a margin is really much more like an initial deposit with the market place, like the deposit one places with a real estate agent when you buy a house. It guarantees that you are able to pay for your losses, beyond which the broker and exchange will ask you to top up or (if you can't) to liquidate your position.

There are two margins that are described on most futures exchanges: initial margin and maintenance margin. Initial margin is the minimum amount that is required to trade a single contract. Suppose you trade and lose money consistently such that your margin falls below your maintenance margin, then you will get a call from your broker asking you to top up your margin account, or they will liquidate the position for you.

The key thing to note here is that some brokers list different margin requirements for interday vs. intraday trading. For example, the corn contract has an interday margin requirement of $1,600 or so; if I long corn, and decide to hold the position over a day or two after the two market sessions close, then I need to make sure I have at least $1,600 per contract traded, and that I don't lose enough on my position to get a margin call. If, however, I am focusing largely on intraday trading, some brokers allow me to trade for as little as $800 margin.

This is especially pertinent for certain expensive contracts, like the E-Mini S&P 500, which the Exchange charges around $5,600 as initial margin. If your broker does not distinguish between intraday vs. interday margins, the S&P Emini might be out of your reach if you are starting with a small account (like me).