The payment of taxes gives a right to protection. ~James M. Wayne
Once you have an overview of what futures markets are, why they exist
and how they work, the next step is to consider various ways in which
you may be able to participate in futures trading. There are a number of
alternatives and the only best alternative--if you decide to participate
at all--is whichever one is best for you. In addition to describing
several possibilities, the pages that follow suggest questions you
should ask and information you should obtain before making a decision.
Also discussed is the opening of a futures trading account, the
regulatory safeguards provided participants in futures markets, and
methods for resolving disputes, should they arise.
Deciding How to Participate
At the risk of oversimplification, choosing a method of participation is
largely a matter of deciding how directly and extensively you,
personally, want to be involved in making trading decisions and managing
your account. Many futures traders prefer to do their own research and
analysis and make their own decisions about what and when to buy and
sell. That is, they manage their own futures trades in much the same way
they would manage their own stock portfolios. Others choose to rely on
or at least consider the recommendations of a brokerage firm or account
executive. Some purchase independent trading advice. Others would rather
have someone else be responsible for trading their account and therefore
give trading authority to their broker. Still others purchase an
interest in a commodity trading pool.
There's no formula for deciding. Your decision should, however, take
into account such things as your knowledge of and any previous
experience in futures trading, how much time and attention you are able
to devote to trading, the amount of capital you can afford to commit to
futures, and, by no means least, your individual temperament and
tolerance for risk. The latter is important. Some individuals thrive on
being directly involved in the fast pace of futures trading, others are
unable, reluctant, or lack the time to make the immediate decisions that
are frequently required. Some recognize and accept the fact that futures
trading all but inevitably involves having some losing trades. Others
lack the necessary disposition or discipline to acknowledge that they
were wrong on this particular occasion and liquidate the position.
Many experienced traders thus suggest that, of all the things you need
to know before trading in futures contracts, one of the most important
is to know yourself. This can help you make the right decision about
whether to participate at all and, if so, in what way.
In no event, it bears repeating, should you participate in futures
trading unless the capital you would commit its risk capital. That is,
capital which, in pursuit of larger profits, you can afford to lose. It
should be capital over and above that needed for necessities,
emergencies, savings and achieving your long-term investment objectives.
You should also understand that, because of the leverage involved in
futures, the profit and loss fluctuations may be wider than in most
types of investment activity and you may be required to cover
deficiencies due to losses over and above what you had expected to
commit to futures.
Trade Your Own Account
This involves opening your individual trading account and--with or
without the recommendations of the brokerage firm--making your own
trading decisions. You will also be responsible for assuring that
adequate funds are on deposit with the brokerage firm for margin
purposes, or that such funds are promptly provided as needed.
Practically all of the major brokerage firms you are familiar with, and
many you may not be familiar with, have departments or even separate
divisions to serve clients who warn to allocate some portion of their
investment capital to futures trading. All brokerage firms conducting
futures business with the public must be registered with the Commodity
Futures Trading Commission (CFTC, the independent regulatory agency of
the federal government that administers the Commodity Exchange Act) as
Futures Commission Merchants or Introducing Brokers and must be Members
of National Futures Association (NFA, the industrywide self-regulatory
Different firms offer different services. Some, for example, have
extensive research departments and can provide current information and
analysis concerning market developments as well as specific trading
suggestions. Others tailor their services to clients who prefer to make
market judgments and arrive at trading decisions on their own. Still
others offer various combinations of these and other services.
An individual trading account can be opened either directly with a
Futures Commission Merchant or indirectly through an Introducing Broker.
Whichever course you choose, the account itself will be carried by a
Futures Commission Merchant, as will your money. Introducing Brokers do
not accept or handle customer funds but most offer a variety of trading-
Futures Commission Merchants are required to maintain the funds and
property of their customers in segregated accounts, separate from the
firm's own money.
Along with the particular services a firm provides, discuss the
commissions and trading costs that will be involved. And, as mentioned,
clearly understand how the firm requires that any margin calls be met.
If you have a question about whether a firm is properly registered with
the CFTC and is a Member of NFA, you can (and should) contact NFA's
Information Center toll-free at 800-621-3570 (within Illinois call 800-
Have Someone Manage Your Account
A managed account is also your individual account. The major difference
is that you give someone rise--an account manager--written power of
attorney to make and execute decisions about what and when to trade. He
or she will have discretionary authority to buy or sell for your account
or will contact you for approval to make trades he or she suggests. You,
of course, remain fully responsible for any losses which may be incurred
and, as necessary, for meeting margin calls, including making up any
deficiencies that exceed your margin deposits.
Although an account manager is likely to be managing the accounts of
other persons at the same time, there is no sharing of gains or losses
of other customers. Trading gains or losses in your account will result
solely from trades which were made for your account.
Many Futures Commission Merchants and Introducing Brokers accept managed
accounts. In most instances, the amount of money needed to open a
managed account is larger than the amount required to establish an
account you intend to trade yourself. Different firms and account
managers, however, have different requirements and the range can be
quite wide. Be certain to read and understand all of the literature and
agreements you receive from the broker.
Some account managers have their own trading approaches and accept only
clients to whom that approach is acceptable. Others tailor their
trading to a client's objectives. In either case, obtain enough
information and ask enough questions to assure yourself that your money
will be managed in a way that's consistent with your goals.
Discuss fees. In addition to commissions on trades made for your
account, it is not uncommon for account managers to charge a management
fee, and/or there may be some arrangement for the manager to participate
in the net profits that his management produces. These charges are
required to be fully disclosed in advance. Make sure you know about
every charge to be made to your account and what each charge is for.
While there can be no assurance that past performance will be indicative
of future performance, it can be useful to inquire about the track
record of an account manager you are considering. Account managers
associated with a Futures Commission Merchant or Introducing Broker must
generally meet certain experience requirements if the account is to be
traded on a discretionary basis.
Finally, take note of whether the account management agreement includes
a provision to automatically liquidate positions and close out the
account if and when losses exceed a certain amount. And, of course, you
should know and agree on what will be done with profits, and what, if
any, restrictions apply to withdrawals from the account.
Use a Commodity Trading Advisor
As the term implies, a Commodity Trading Advisor is an individual (or
firm) that, for a fee, provides advice on commodity trading, including
specific trading recommendations such as when to establish a particular
long or short position and when to liquidate that position. Generally,
to help you choose trading strategies that match your trading
objectives, advisors offer analyses and judgments as to the prospective
rewards and risks of the trades they suggest. Trading recommendations
may be communicated by phone, wire or mail. Some offer the opportunity
for you to phone when you have questions and some provide a frequently
updated hotline you can call for a recording of current information and
Even though you may trade on the basis of an advisor's recommendations,
you will need to open your own account with, and send your margin
payments directly to, a Futures Commission Merchant. Commodity Trading
Advisors cannot accept or handle their customers funds unless they are
also registered as Futures Commission Merchants.
Some Commodity Trading Advisors offer managed accounts. The account
itself, however, must still be with a Futures Commission Merchant and in
your name, with the advisor designated in writing to make and execute
trading decisions on a discretionary basis.
CFTC Regulations require that Commodity Trading Advisors provide their
customers, in advance, with what is called a Disclosure Document. Read
it carefully and ask the Commodity Trading Advisor to explain any
points you don't understand. If your money is important to you, so is
the information contained in the Disclosure Document!
The prospectus-like document contains information about the advisor, his
experience and, by no means least, his current (and any previous)
performance records. If you use an advisor to manage your account, he
must first obtain a signed acknowledgment from you that you have
received and understood the Disclosure Document. As in any method of
participating in futures trading, discuss and understand the advisor's
fee arrangements. And if he will be managing your account, ask the same
questions you would ask of any account manager you are considering.
Commodity Trading Advisors must be registered as such with the CFTC, and
those that accept authority to manage customer accounts must also be
Members of NFA. You can verify that these requirements have been met by
calling NFA toll-free at 800-621-3570 (within Illinois call 800-572-
Participate in Commodity Pool
Another alternative method of participating in futures trading is
through a commodity pool, which is similar in concept to a common stock
mutual fund. It is the only method of participation in which you will
not have your own individual trading account. Instead, your money will
be combined with that of other pool participants and, in effect, traded
as a single account. You share in the profits or losses of the pool in
proportion to your investment in the pool. One potential advantage is
greater diversification of risks than you might obtain if you were to
establish your own trading account. Another is that your risk of loss is
generally limited to your investment in the pool, because most pools are
formed as limited partnerships. And you won't be subject to margin
Bear in mind, however, that the risks which a pool incurs in any given
futures transaction are no different than the risks incurred by an
individual trader. The pool still trades in futures contracts which are
highly leveraged and in markets which can be highly volatile. And like
an individual trader, the pool can suffer substantial losses as well as
realize substantial profits. A major consideration, therefore, is who
will be managing the pool in terms of directing its trading.
While a pool must execute all of its trades through a brokerage firm
which is registered with the CFTC as a Futures Commission Merchant, it
may or may not have any other affiliation with the brokerage firm. Some
brokerage firms, to serve those customers who prefer to participate in
commodity trading through a pool, either operate or have a relationship
with one or more commodity trading pools. Other pools operate
A Commodity Pool Operator cannot accept your money until it has provided
you with a Disclosure Document that contains information about the pool
operator, the pool's principals and any outside persons who will be
providing trading advice or making trading decisions. It must also
disclose the previous performance records, if any, of all persons who
will be operating or advising the pool lot, if none, a statement to that
effect). Disclosure Documents contain important information and should
be carefully read before you invest your money. Another requirement is
that the Disclosure Document advise you of the risks involved.
In the case of a new pool, there is frequently a provision that the pool
will not begin trading until (and unless) a certain amount of money is
raised. Normally, a time deadline is set and the Commodity Pool Operator
is required to state in the Disclosure Document what that deadline is
(or, if there is none, that the time period for raising, funds is
indefinite). Be sure you understand the terms, including how your money
will be invested in the meantime, what interest you will earn (if any),
and how and when your investment will be returned in the event the pool
does not commence trading.
Determine whether you will be responsible for any losses in excess of
your investment in the pool. If so, this must be indicated prominently
at the beginning of the pool's Disclosure Document.
Ask about fees and other costs, including what, if any, initial charges
will be made against your investment for organizational or
administrative expenses. Such information should be noted in the
Disclosure Document. You should also determine from the Disclosure
Document how the pool's operator and advisor are compensated.
Understand, too, the procedure for redeeming your shares in the pool,
any restrictions that may exist, and provisions for liquidating and
dissolving the pool if more than a certain percentage of the capital
were to be lost,
Ask about the pool operator's general trading philosophy, what types of
contracts will be traded, whether they will be day-traded, etc.
With few exceptions, Commodity Pool Operators must be registered with
the CFTC and be Members of NFA. You can verify that these requirements
have been met by contacting NFA toll-free at 800-621-3570 (within
Illinois call 800-572-9400).
Regulation of Futures Trading
Firms and individuals that conduct futures trading business with the
public are subject to regulation by the CFTC and by NFA. All futures
exchanges are also regulated by the CFTC.
NFA is a congressionally authorized self-regulatory organization subject
to CFTC oversight. It exercises regulatory Authority with the CFTC over
Futures Commission Merchants, Introducing Brokers, Commodity Trading
Advisors, Commodity Pool Operators and Associated Persons (salespersons)
of all of the foregoing. The NFA staff consists of more than 140 field
auditors and investigators. In addition, NFA has the responsibility for
registering persons and firms that are required to be registered with
Firms and individuals that violate NFA rules of professional ethics and
conduct or that fail to comply with strictly enforced financial and
record-keeping requirements can, if circumstances warrant, be
permanently barred from engaging in any futures-related business with
the public. The enforcement powers of the CFTC are similar to those of
other major federal regulatory agencies, including the power to seek
criminal prosecution by the Department of Justice where circumstances
warrant such action.
Futures Commission Merchants which are members of an exchange are
subject to not only CFTC and NFA regulation but to regulation by the
exchanges of which they are members. Exchange regulatory staffs are
responsible, subject to CFTC oversight, for the business conduct and
financial responsibility of their member firms. Violations of exchange
rules can result in substantial fines, suspension or revocation of
trading privileges, and loss of exchange membership.
Words of Caution
It is against the law for any person or firm to offer futures contracts
for purchase or sale unless those contracts are traded on one of the
nation's regulated futures exchanges and unless the person or firm is
registered with the CFTC. Moreover, persons and firms conducting
futures-related business with the public must be Members of NFA. Thus,
you should be extremely cautious if approached by someone attempting to
sell you a commodity-related investment unless you are able to verify
that the offeror is registered with the CFTC and is a Member of NFA.
In a number of cases, sellers of illegal off-exchange futures contracts
have labeled their investments by different names--such as "deferred
delivery," "forward" or "partial payment" contracts--in an attempt to
avoid the strict laws applicable to regulated futures trading. Many
operate out of telephone boiler rooms, employ high-pressure and
misleading sales tactics, and may state that they are exempt from
registration and regulatory requirements. This, in itself, should be
reason enough to conduct a check before you write a check.
You can quickly verify whether a particular firm or person is currently
registered with the CFTC and is an NFA Member by phoning NFA toll-free
at 800-621-3570 (within Illinois call 800-572-9400).
Establishing an Account
At the time you apply to establish a futures trading account, you can
expect to be asked for certain information beyond simply your name,
address and phone number. The requested information will generally
include (but not necessarily be limited to) your income, net worth, what
previous investment or futures trading experience you have had, and any
other information needed in order to advise you of the risks involved in
trading futures contracts. At a minimum, the person or firm who will
handle your account is required to provide you with risk disclosure
documents or statements specified by the CFTC and obtain written
acknowledgment that you have received and understood them.
Opening a futures account is a serious decision--no less so than making
any major financial investment--and should obviously be approached as
such. Just as you wouldn't consider buying a car or a house without
carefully reading and understanding the terms of the contract, neither
should you establish a trading account without first reading and
understanding the Account Agreement and all other documents supplied by
your broker. It is in your interest and the firm's interest that you
dearly know your rights and obligations as well as the rights and
obligations of the firm with which you are dealing before you enter into
any futures transaction. If you have questions about exactly what any
provisions of the Agreement mean, don't hesitate to ask. A good and
continuing relationship can exist only if both parties have, from the
outset, a clear understanding of the relationship.
Nor should you be hesitant to ask, in advance, what services you will be
getting for the trading commissions the firm charges. As indicated
earlier, not all firms offer identical services. And not all clients
have identical needs. If it is important to you, for example, you might
inquire about the firm's research capability, and whatever reports it
makes available to clients. Other subjects of inquiry could be how
transaction and statement information will be provided, and how your
orders will be handled and executed.
If a Dispute Should Arise
All but a small percentage of transactions involving regulated futures
contracts take place without problems or misunderstandings. However, in
any business in which some 150 million or more contracts are traded each
year, occasional disagreements are inevitable. Obviously, the best way
to resolve a disagreement is through direct discussions by the parties
involved. Failing this, however, participants in futures markets have
several alternatives (unless some particular method has been agreed to
Under certain circumstances, it may be possible to seek resolution
through the exchange where the futures contracts were traded. Or a claim
for reparations may be filed with the CFTC. However, a newer, generally
faster and less expensive alternative is to apply to resolve the
disagreement through the arbitration program conducted by National
Futures Association. There are several advantages:
* You can elect, if you prefer, to have arbitrators who have no
connection with the futures industry.
* You do not have to allege or prove that any law or rule was broken
only that you were dealt with improperly or unfairly.
* In some cases, it may be possible to conduct arbitration entirely
through written submissions. If a hearing is required, it can generally
be scheduled at a time and place convenient for both parties.
* Unless you wish to do so, you do not have to employ an attorney.
excerpted from 'Understanding Opportunities and Risks in Futures Trading'
Copyright 1986 by National Futures Association 1-800-621-3570
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