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Participating in Futures Trading

This publication is the property of the National Futures Association.

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Now that 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 may 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 delegate trading authority to their broker or a
trading advisor. 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 your individual temperament and tolerance for risk. The importance of the latter cannot be overemphasized. 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 a 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 should you participate in futures trading unless the capital you would commit is 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 a brokerage firm or an independent Commodity Trading Advisor—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, and that additional funds are promptly provided as needed.

Most major brokerage firms have departments or even separate divisions to serve clients who want to allocate some portion of their investment capital to futures trading. Some firms specialize exclusively in futures trading. All brokerage firms conducting futures business with the public must be registered as Futures Commission Merchants or Introducing Brokers with the Commodity Futures Trading Commission (CFTC), the independent regulatory agency of the federal government that administers the Commodity Exchange Act, and must be Members of National Futures Association (NFA), the industrywide self-regulatory organization.

Different firms offer different services. Some 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 through an Introducing Broker. Whichever course you choose, the account itself will be carried by a Futures Commission Merchant, as will your money. Futures Commission Merchants are required to maintain the funds and property of their customers in segregated accounts, separate from the firm’s own money. Introducing Brokers do not accept or handle customer funds but most offer a variety of trading-related services.

Along with the particular services a firm provides, discuss the commission and trading costs that will be involved. You should 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 should contact NFA’s Information Center tollfree at (800) 621-3570 or check them out by visiting NFA’s online Background Affiliation Status Information Center (BASIC) at NFA’s web site (

Have Someone Manage Your Account 
A managed account is also your individual account. The major difference is that you give someone else—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. You, of course, remain fully responsible for any losses that may be incurred.

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 that were made for your account.

Most Futures Commission Merchants and Introducing Brokers accept managed accounts or can assist in placing your investment with a professional account manager with whom the firm has a relationship. 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 and risk tolerance. 

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.

Account managers associated with a Futures Commission Merchant or Introducing Broker must meet certain experience requirements if the account is to be traded on a discretionary basis.

Many 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 that manage accounts 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. Your money is important to you; so is the information contained in the Disclosure Document!

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. 

The Disclosure Document contains information about the advisor, his experience and 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.

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. You should know and agree on what will be done with profits, and what, if any, restrictions apply to withdrawals from the account.

Commodity Trading Advisors who manage accounts must be registered as such with the CFTC and must also be Members of NFA. You can verify that these requirements have been met by calling NFA toll-free at (800) 621-3570 or by checking NFA’s online BASIC system.

Participate in a 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 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 among commodities 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 calls.

Bear in mind, however, that the risks a pool incursb 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 that 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 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 independently. 

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 extensive past performance records of the pool or its principals. 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 whether any initial charges will be made against your investment for organizational or administrative expenses. Such information should be noted in the Disclosure Document along with a break-even analysis to indicate how much profit the pool must make in the first year to cover its fees. 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 calling NFA tollfree at (800) 621-3570 or by checking NFA’s online BASIC system.

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 U.S. futures exchanges are regulated by the CFTC.

NFA is a congressionally authorized self-regulatory organization subject to CFTC oversight. It exercises regulatory authority over Futures Commission Merchants, Introducing Brokers, Commodity Trading Advisors, Commodity Pool Operators and Associated Persons (salespersons) of all of the foregoing. NFA staff includes nearly 150 field auditors and investigators. In addition, NFA is responsibile for registering persons and firms required to be registered with the CFTC, including exchange floor brokers and traders.

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 expulsion from exchange membership. 

Words of Caution 
It is generally against the law for any person or firm to offer futures contracts or options on futures contracts for purchase or sale unless those contracts are traded on a regulated futures exchange 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, be extremely cautious if approached by someone attempting to sell you a commodity-related investment unless you are able to verify that these requirements are met. 

Be at least equally cautious of anyone soliciting the retail public for investments in nonexchange traded, foreign exchange (Forex) contracts. If you invest without first carefully checking out the firm promoting them, you and your money could quickly become strangers! Contact the CFTC, NFA, the Securities and Exchange Commission (SEC), or the securities regulatory agency or attorney general in your state. If you wait until after your investment—and possibly the firm itself—are gone, there’s generally little anyone can do to help you recover it.

Other sales pitches that should raise warning flags include: Investments in illegal offexchange futures contracts that may be called
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. Firms peddling these often operate out of telephone boiler rooms, employ high-pressure selling tactics, and may state that they are exempt from registration and regulatory requirements. That, in itself, should be reason enough to conduct a check before writing a check.

You can quickly verify whether a particular firm or person is currently registered with CFTC and is an NFA Member by phoning NFA
toll-free at (800) 621-3570 or checking NFA’s online BASIC system. You can also inquire as to whether a firm or person has been the subject of disciplinary actions by the CFTC, NFA or an exchange.

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 clearly 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 what the 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 millions of 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 in advance).

One option is to file a claim for reparations at the CFTC. However, a more informal, and generally faster, alternative is to resolve the dispute through arbitration, either at the exchange where the contracts were traded or at NFA. There are several advantages to NFA arbitration:

• You do not have to use an attorney.

• You can state your claim in your own words without citing any law or rule.

• You can elect, if you prefer, to have a majority of arbitrators who have no connection with the futures industry.

• Parties to an NFA arbitration can seek resolution through NFA’s mediation program at no additional charge.

• In some cases, it may be possible to conduct arbitration entirely through written submissions. If a hearing is required, NFA can hold hearings in many metropolitan areas throughout the country. 

For an explanation of the arbitration program and how it works, contact NFA for a free copy of NFA Arbitration: Resolving Customer Disputes.

Past performance is not necessarily indicative of future results. The risk of loss exists in futures and options trading.

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