Each introducing broker has a relationship with a FCM. The FCM has the personnel on the floor of the futures exchanges to execute trades. They also have the trading platforms where clients can place trades online and the account management is done by the FCM. One of the most important features is that all the customer funds are deposited with the FCM in customer segregated accounts.
As you might imagine, introducing brokers are typically smaller offices throughout the country that solicit business for the FCMs. Some of them are one-person operations and other are larger multi-location businesses. The theory behind the use of introducing brokers is that they are better able to serve their clients. An FCM is focused on executing trades and maintaining the infrastructure of trading. It makes sense to outsource the prospecting and servicing of accounts to the introducing brokers.
It works out both ways, as an introducing broker probably doesn’t have the financial resources to execute trades for their clients. This would include having a seat on all the futures exchanges, traders on the floor, maintaining daily accounting of client trades and balances, creating and maintaining trading platforms and many other large expenses.
Most FCMs probably wouldn’t find it financially feasible to open offices around the country. Many commodity firms are in rural areas for hedging clients, and that would be an even further stretch. They would have to hire brokers and maintain the offices, which is not an easy thing when it comes to the brokerage world. It makes sense to let others start up the brokerage offices and use their infrastructure for trading.
When someone starts an IB, they will form a relationship with an FCM. The FCM will charge the IB a fee for each trade they place. This is how the FCM makes money from the IB and this is how the IB pays the FCM for their services.
For open outcry markets, the FCM might charge the IB $12 per trade. Obviously, the IB will have to markup this amount to their clients in order to make money. Some full service commodity brokers might charge $60 a round turn in brokerage commissions. It might sound like the broker is making a lot of money, but the broker has additional overhead to pay. It also depends on how many trades the client eventually makes. Rates are negotiated and the larger IBs typically have lower rates tha a smaller IB.
One of the main expenses of an introducing broker is advertising. Some brokers focus on their local market and depend on referral business. However, most brokers have to spend a lot of money on advertising to bring in clients and constantly replace the clients who lost their money. Many commodity traders don’t last past six months. Brokers who make good trade recommendations often do much better in the long run.
Online futures trading has become more competitive among brokers and profit margins are much tighter. People who trade online are typically short-term traders and they trade a lot more. They are also seeking the lowest rates possible. Some online brokers only make cents on each trade. Volume is often the name of the game for online commodity brokers.
If you plan on opening an account for trading commodities and futures, you will probably open it with an introducing broker. The clearing firms do have some brokers internally who handle accounts, but the majority of their business comes from introducing brokers. When you hear the term commodity broker, someone is probably referring to an introducing broker. That is the official designation by the CFTC for brokerage firms that are not FCMs.