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The Story Behind the Financial Integrity of the U.S. Futures Markets

Trading volume in futures contracts and options on futures on U.S. markets has risen to more than 500 million contracts annually. And the dollar value of futures contracts traded currently exceeds severalfold the dollar value of common stocks traded on all U.S. stock exchanges.

A requisite for this growth has been the financial integrity of futures markets. While trading in futures contracts obviously involves risks related to price changes, market participants have historically had little reason to be concerned about the security of their funds.

Customer losses due to the insolvency of a futures brokerage firm have been virtually non-existent. Indeed, such losses have totaled less over 50 years than the Securities Investor Protection Corporation has paid, on the average, to reimburse customers of the securities industry for member firm insolvency losses each year.

For anyone considering participation in the nation’s futures markets, the reasons behind this continuing and impressive record of financial soundness are worth knowing about.

Daily Cash Settlement
As futures prices move upward and downward, the market value of customers’ open positions increases and decreases. Resulting gains and losses from futures trading are credited or charged to each customer’s account each day following the close of trading. Subject to existing margin requirements, all gains deposited to a customer’s account through this procedure become immediately available to the customer.

Margin Requirements
Buyers and sellers of futures contracts are required to at all times maintain sufficient funds on deposit in their brokerage accounts to cover losses that might be incurred as a result of price changes. Margin deposits provide protection for all market participants. In volatile markets, the exchanges increase margin requirements accordingly. The availability of such funds is what makes daily cash settlements possible under all market conditions.

The Exchange Clearing Houses
Once each purchase of a futures contract is precisely matched to the corresponding sale (a process which occurs each day), the clearing organization of the exchange where the contracts are traded becomes the “buyer to every seller and the seller to every buyer.” The purpose: provide a mechanism that assures the payment of all gains and collection of all losses on a daily basis.

Capital Requirements
Every firm that conducts business with the public as a Futures Commission Merchant must have and maintain sufficient capital to meet its financial obligations to its customers. These requirements are subject to continuous audit and stringent enforcement. Regulatory agencies have the authority to determine compliance on a daily basis and in volatile markets clearing organization can demand that a firm provide additional capital on one hour’s notice!

Segregated Accounts
Firms and principals of firms in the futures industry are required to maintain their customers’ funds and margin deposits in bank accounts which are totally separate from their own. Rules further stipulate that such funds can be used only for the purposes the customers intended and can at no time be commingled with the firm’s funds or the funds of the firm’s principals. Compliance is strictly enforced and regulators possess power to take such immediate action as is considered necessary to protect the security of customers’ money.

Transfer of Market Positions
Should a firm be determined to be in a financial situation that could potentially jeopardize the safety of its customers’ funds, it can be directed to immediately cease operations and transfer all open customer positions in the market to a firm which is financially sound. This is to ensure that adequately margined positions with a troubled firm will not be liquidated at a time when the customer may not wish for them to be liquidated.

Regulation
Regulation of the U.S. futures industry is primarily self-regulation, with the role of the federal Commodity Futures Trading Commission being principally an oversight role (to determine that self-regulation is continuous and effective). Of the total expenditures on futures regulation, more than three-fifths of the cost is presently being paid by the exchanges where futures contracts are traded and by National Futures Association (NFA), the industrywide self-regulatory organization authorized by Congress and established in 1982. The purpose of self-regulation is to assure that those who conduct futures trading business with the public do so in a professional, ethical and honest manner.

NFA’s responsibilities include screening, testing and registering persons applying to conduct business in the futures industry. NFA and the exchanges have responsibility for auditing and enforcing compliance with industry rules. These rules encompass financial requirements, segregation of customers’ funds, accounting procedures, sales activities and, in the case of the exchanges, floor trading practices.

Although there is no guarantee against customer losses due to the insolvency of a futures brokerage firm, the above mechanisms are designed to ensure the financial integrity of this nation’s futures markets, and have in fact minimized the risk of customer losses.

Trading Environment

There’s no sense in denying it, the markets are chaotic and unpredictable; sometimes more so and sometimes less so, but you have to admit that the chances of knowing where the next tick will be are one in three.

It’s important to not allow yourself to be unduly influenced by the sense of uncertainty that can prevail over the marketplace. Uncertainty can breed fear, and a frightened trader has no business being in the market.

Depending on your personality, you may be easily swayed by the market action, becoming stressed out when the markets are particularly volatile. It’s critical that you minimize feelings of stress and uncertainty so that you can trade calmly; being objective in your mindset will enable you to improve your performance.

One source of anxiety for some people is the actual physical environment in which they trade. For some people, the disarray of their workspace can grate on their nerves and be a hidden source of stress. Make sure that your physical environment matches your personality. Doing so will enhance your trading performance.

People differ in terms of how orderly and tidy they prefer their workspace. Some people don’t mind a workspace that is disorganized. They feel it has a casual and comfortable, homey feel. But others find it extremely bothersome. They feel stressed out when they have to work in an environment that is not organized. To them disorganization means chaos, and chaos is associated with stress.

Which type of person are you? Do you prefer a neat and orderly workspace or do you care? If you do care, it is vital that you take steps to arrange your workspace. Make sure that it is clean and orderly. Remove all items from your desk and anything that interferes with you focusing exclusively on your screens.

You’ll find that by keeping the area neat and orderly, you’ll feel less stressed out and in control. That said, other people find an orderly appearance equally distracting. They find such an environment sterile and uninspiring. They would rather have items around their workspace that inspire them.

For example, placing pictures of their family and friends by them reminds them why they are motivated to trade. Having a few of their favorite trading books by them also gives them a sense of security. Rather than being sources of distraction, such items make them feel comfortable.

I once visited with a trader who had the most unusual trading environment I’ve ever seen.  When I entered his trading room, I was surprised to see that the walls were painted black. There was black flooring. The ceiling was black with sparkles in it.  The illumination in the room was from track lighting. On one wall there was a built-in, refrigerated beer keg.

Naturally, I wanted to know why his trading environment was so unusual. His answer was that he felt most comfortable in a cocktail lounge. He allowed himself one cold beer to help him relax while trading.  He was disciplined and an excellent trader. I had to admire him as a man who knows what he likes and knows himself.

Whatever environment you prefer to work in, it is important to make sure that it matches your personality. If a disorganized workspace bothers you, then it is important to take active steps to clean it up as soon as possible. Unless you do, it may serve as a hidden source of stress. By taking steps to match your environment to your personality, you’ll trade in a calm, objective mindset.

About the Author: Joe Ross has been trading and investing since his first trade at the age of 14, and is a well known Master Trader and Investor. He has survived all the up and downs of the markets because of his adaptable trading style, using a low-risk approach that produces consistent profits.
Read more at http://www.tradingeducators.com

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