As commodity traders, we spend our time worrying about markets and the directions they’re heading. Obviously, to trade we need to have an account with a commodity broker, but we rarely have time to give a thought to the people who sit on the other side of the trading desk. Did you ever wonder what it takes to become a commodity broker? If not, let’s take a look.
To start with, most commodity brokers have a strong financial background before they ever come close to a commodity trading desk. One of the most popular degrees for a commodity broker is a Bachelor’s degree in accounting, although MBAs with a financial focus are also quite common. Accounting degrees are available at business schools of many colleges – for example at the NYU Stern School of Business – but an increasingly popular option is to take an online accounting degree. For instance, if you look at Bryant & Stratton’s accounting program, you will see it is possible to complete an online accounting degree in four years – while continuing to hold down a fulltime job.
The examination that is specific to commodity futures brokers is the Series 3 exam. It should be noted that this is different to the Series 7 exam, which is the one that the SEC requires all stockbrokers to take. The Series 3 exam is divided into two parts, the first of which addresses the operation of the futures market, while the second looks at market regulations. As commodity traders, we would feel relatively comfortable with the first part of the exam, but the second part covers a lot of new ground.
Topics in the first part include things such as terminology, the basics of futures contracts, margin requirements, fundamental and technical analysis, types of orders, hedging, spread trading and so on. The second part contains a number of questions that appear open to interpretation – for example, describing a scenario and asking how the broker would act in their client’s best interest. However, all of the correct answers can be traced back to specific market regulations.
Once a broker has completed and passed the Series 3 exam, the next stage of the process is a rigorous background check. Candidates fill out an 8-R form for the National Futures Association that details things such as their last 10 years of employment history and where they have lived for the past 5 years. Any criminal history is also included, as is any misconduct or disciplinary actions taken against the candidate in other licensed financial professions. This information is then provided to the FBI, which conducts a thorough background check before a temporary license is issued.
Once the commodity broker has their license, they need to secure a position at an brokerage firm. Basically, there are two types of brokerage that they can look to join, states JAFX. The first of these is a Futures Commission Merchant (FCM), which accepts orders for commodity contracts and holds customer funds to margin. In most respects, an FCM is similar to a securities broker-dealer. The majority of FCMs in the United States are located in New York or in Chicago, where they are close to the trading action.
However, most commodity traders do not deal directly with an FCM – instead, they work through an Introducing Broker (IB), the second main type of brokerage that a newly qualified commodity broker can join. An IB solicits and accepts customer orders, but they do not actually trade or hold customer funds to margin. Instead, they act as an intermediary between the commodity trader and the FCM.
In addition to FCMs and IBs, there are a number of other types of brokerage, although these are not as prevalent. For instance, a Commodity Trading Adviser (CTA) provides advice on the trading of commodity contracts, acting in much the same way as a financial adviser or mutual fund manager does on the stock market. Like IBs, CTAs don’t execute trades directly nor do they hold customer funds to margin. The other category of commodity broker is a Commodity Pool Operator (CPO) – this is basically the same as a stock market mutual fund, except that a CPO holds commodity futures, not stocks.Once a commodity broker starts to work, their job involves a combination of commodity market analysis and sales to clients. However, in many cases, sales will predominate, as many larger brokerages have research departments that provide brokers with trading recommendations and supporting analysis – rather than the broker having to do the analysis by themselves. Coming back to the licensing process, this is why it is not essential that new commodity brokers have previous successful commodity trading experience.
At this point, the commodity broker will be making their money primarily from commissions on client trades. While this would seem to be a conflict of interest – the broker is incented to generate as many trades as possible on the client accounts – in reality, the most successful commodity brokers generally act in their clients’ best interests. This is because while generating a lot of commissions may drive short-term profits, in the long-term this means that clients will not get good returns – and therefore are likely to leave for another commodity brokerage firm. However, some of the less reputable brokerages do engage in high-pressure selling tactics, so if you encounter these when you are trading commodities, you should treat these as a signal and walk away.