What Is a Commodity Broker?

Definition and Example of a Commodity Broker

Commodities are tangible goods sold and traded throughout the world; these include agricultural products, industrial metals, and energy sources such as crude oil. In addition to a direct trading market, these products are bought and sold by investors in the form of futures, options, and other financial derivatives. Derivatives are financial contracts that allow an investor to buy or sell the underlying asset or security at a preset price for a specific settlement date. Commodity brokers also handle futures and options in financial products, such as U.S. Treasury bills or T-bills.

Commodity Brokers

Commodity brokers play an integral role in facilitating trading; whether the trades are executed online or over the phone, a commodity broker is essential for getting trades done efficiently. The term "commodity broker" often refers to someone who places commodity trades for their clients. It can also refer to a brokerage firm that handles commodity trades.

For registration purposes, brokerage firms are designated as introducing brokers (IB) or futures commission merchants (FCM). Individuals are designated as associated persons (AP).

Example of a Commodity Broker

For example, suppose an automaker needs to purchase aluminum to be used in the manufacturing process. The company can execute a futures contract for the amount of aluminum to be delivered at a date in the future. The commodity broker would facilitate the trade by quoting the price and executing the contract. They would likely charge a commission or fee for this service.

Regardless of aluminum price movements in the future, the automaker can buy the raw material at the fixed contract price by the settlement date of the contract. As a result, the commodity broker will have helped its client hedge the cost of the raw materials.

How Commodity Brokers Work

Commodity brokers facilitate trading in the commodity markets for the average investor. Other than owning a seat on an exchange and trading in the commodity pits, most people have to trade through a broker.

Commodity brokers have traders on the floor to execute your trades, or they might have a trading platform that places and executes trades electronically. The exchanges rely on brokers to bring business to them. They have their own rules to govern how the brokers conduct business.

It's much easier to conduct business with a few dozen brokerage firms than it is to let hundreds of thousands of people place trades directly with an exchange.

Full-Service Brokers

Commodities were traded only in the commodity pits on exchanges until the 1990s. Most orders were placed by phone through a full-service broker. The typical order went something like this:

A client would call their introducing broker (IB) with a trade they wanted to place. The broker would take the order and time stamp it. They would immediately contact the futures commissions merchant (FCM) that handles the IB's orders; they would then relay the same trade that their client called in, which often went to a phone bank on the exchange floor, where a clerk took the order.

From there, the clerk wrote a ticket for a floor broker in the pits to execute, or they might have sent the order to the pit by hand signal. When the floor broker filled the order in the pit, they would give the ticket to a runner or signal back to the clerk. The clerk would, in turn, call the broker back with the trade confirmation, and the broker, in turn, would call their client back with the full price and financial details of the transaction.

Online Commodity Trading 

A client trading online will log into their broker's trading platform. They will select the market they want to trade in, along with the type of order, price, and quantity. The process can be done with a couple of clicks of the mouse. When the order looks good, the trader will hit the "Buy" or "Sell" button to send the order through. The order is routed instantly to the exchange's trading platform and matched with other similar orders. A market order is filled instantly in most cases, and the trader receives a confirmation on their computer within a second or two.

Online trading is much quicker, much cheaper, and more efficient, but you can still opt for a full-service broker, who allows you to discuss trading opportunities and explore your options. Many brokers offer a mix of the two—where you can speak with a broker and place your trades online.