Brokers

In order to trade futures, you need a brokerage account. What some retail traders are unclear of however is the relationship between an Introducing Broker (IB) and a Futures Commission Merchant (FCM).

Let’s start at the very top of the tree. Futures contracts are traded on an exchange, e.g. CME. The exchange enables trading of futures contracts.

The notional value of a single ES contract is $50 per point. If ES is trading at 4000, then the contract value is 4000 x $50 = $200,000. If you buy one contract at an index value of 4000 and sell it at an index value of 4002.50, your profit is (4002.50 – 4000) x $50 = $125.

To make trading more accessible to more market participants that are unable to deposit the full notional value of a contract in order to trade it, exchanges enable contracts to be traded using margin. This is a percentage of the contract value that is deposited with the exchange to enable trading of that contract to occur. The exchange calculates the margin requirements based upon the volatility of the contract, i.e. how much it is likely to move. The initial margin for a single ES contract is $12,650.

A Futures Commission Merchant (FCM) enables customers to trade futures. They accept customers’ buy and sell orders and charge a commission for each order that they handle. They collect the corresponding margins from customers.

Clearing FCM is a clearing member firm of the exchange and will have placed a significant deposit – a performance bond – at the exchange which is of sufficient size to enable them to place their customers’ orders. There are also Non-Clearing FCMs that similarly take their customers’ orders (and hold the customers’ money on account) but clear their customers’ trades through a Clearing FCM.

So… the FCM holds your money and has the job of placing your orders at the exchange.

An Introducing Broker (IB) deals with client relationships (that’s you) but works with an FCM to have their clients’ trades executed at the exchange. They may offer advise and be better placed to service customer needs due to industry specialisation or customer relationship. Some Introducing Brokers are affiliated with (or guaranteed by) an FCM, typically on an exclusive relationship. Others are independent and will select which FCM a client’s account is opened with based upon that client’s needs.

As we move through the chain from the Exchange, through the FCM and IB to you, you will see that day trading margins get discounted down. The FCM (or the IB) will manage their own risk model to enable much lower margins for trading than those required by the Exchange. You may be trading ES with a $500 day trading margin, but the FCM where your account is held still needs to have $12,650 deposited at the exchange to enable that trade to occur.

Your funds are held with the FCM. Typically an FCM will not provide very aggressive leverage through discounted margin whereas IBs will. It’s one way that an IB can add value. Ultimately though, the business of being an FCM or IB is hard. Commissions are low and highly competitive and there is an ongoing battle to add value through advice, free or discounted access to trading platforms, etc.

Our view is that you want to be as close to the FCM as possible. Commissions are competitive and do not represent the bulk of your trading costs. Exchange and NFA fees are where costs add up. Free or discounted trading platforms can sometimes have missing features or be locked in to a specific broker.

To that end, we tend to hold our accounts directly at FCMs or at the affiliated (or in-house) brokerages of FCMs. Why? Because we don’t need the value-add of free or discounted platforms and the places where we hold our accounts are pretty much as competitive on intraday margins and commissions as anyone else.

Listed below are the companies we like to use for our accounts.

 

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