INSIGHTS

Brokers on the Run

Being a retail broker is tough business. Gone are the days of collecting
easy money for essentially doing nothing more than passing a piece of
cake from one party to another, letting the crumbs fall on the table in the
form of fat commissions and fees. Brokers are getting squeezed by low
margins as customers continually demand cheaper round-turns and
better technology. These dynamics are forcing brokers to create new
business models to stay competitive, changing the face of the brokerage
business and opening new ways for customers to take part in the financial
markets; new ways that were unheard of just a few short years ago. This
article is a glimpse at some of those developments.

Falling Round Turns
It is no secret that transaction costs are a major success factor in the
trading business, especially for those transacting frequently or
dealing in large orders. As daily average true ranges in the stock
market indexes continue to fall, low transaction costs are one of the
few ways day traders can gain an edge. If you cannot cover
commissions and fees with one tick in the futures or a small price
move in a stock, the cards are stacked against you.
This decreasing cost trend will likely continue, which is good
news for customers.
But brokers trying to differentiate themselves through cheap
round turns alone are fighting a losing battle as lower and lower
fees will continue to squeeze brokers’ profit margins. One of the only
ways for them to combat this trend is by providing customers access
to innovative technology. Another, more important way, is by
offering unique services.
Life is Live
If you’ve ever had the chance to experience the trading room of a
large investment bank or the floor of an open outcry exchange you
will probably never forget it. It is an electrifying environment, packed
with energy and the inescapable feeling that you are right at the
source of whatever it is that is happening. When banks downsize or
exchanges close pits in favour of electronic markets, many traders

22 February 2006 www.traders-mag.com

and former floor locals decide to continue
trading on their own. However, they often
find themselves alone and isolated at home,
staring into their screens and wondering
what is missing. Eventually they discover
that they truly miss the comradeship, the
buzz, and the edge they had on the
exchange floor or in the trading room.
Recreating the Trading Room
Experience
Enter the so-called trading arcades, trading
bureaus and prop shops. These are terms for
a broker model that has become very
popular in the last couple of years. Their aim
is to provide a trading room environment for
clients seeking interaction with other
professionals and a more vibrant work
atmosphere.
Typically these commercial operations
are brokerage organisations offering desk
space, IT equipment, software, network
access and banking, as well as training and
seminars for private traders. The idea is to
create an environment in which everyone
benefits. Traders get cutting edge
technology, speedy market access, low
commissions and access to know-how, as
well as contact with other traders, mentors,
and even research specialists. If the broker
succeeds in creating a positive environment
for his clients, he gets a room full of paying
customers for all those services. However
some rooms are often more than just a place
to trade. Many of them focus on recruiting
talented traders to manage the firm’s own
pool of funds, essentially creating
proprietary trading departments within the
commercial trading room.
The Start of a Movement
The seed of the trading room success story
was planted in 1997 when a group of traders
in London started a company called Mac
Futures. The firm was designed to give
professionals, downsized out of jobs at
banks and exchanges, a quality environment
in which to work with other like-minded
professionals. Mac Futures co-founder
Magnus Greaves recalls that business got off
to a strong start. “At the time there were a
lot of former institutional traders looking for
a centralized location to conduct their
business. We simply provided the necessary
infrastructure and in the process created
multiple revenue streams for our company
by charging rent for desk space and
technology, and commission fees for
transactions. We also allowed certain traders
to manage the company’s funds, creating
yet another revenue source.”
Trader Garden
But Greaves says Mac Futures really began
to take off when the company introduced a
training program for new traders. “Early on
we decided to introduce training programs
because we noticed a lot of former floor
traders had trouble adjusting to screen
trading. We wanted young people we could
educate from the start before they
developed any bad habits.” Entrants didn’t
have to pay for the course, but if they
graduated they had a high probability of
becoming good traders. The decision to start
a training program heralded an era of
success that took Mac Futures and a number
of their proprietary traders to unimagined
heights.
The firm ended up opening offices
throughout Europe including, Gibraltar and
Paris as well as locations such as New York,
Montreal, and Sydney. Greaves says branch
offices facilitated the idea of providing a
total life style solution for clients interested
in the freedom to trade their accounts in
desirable destinations around the world. “In
the end we had ten offices serving more
than 500 traders.” In 2003, the firm was sold
to American broker Refco.
The Fruits of Success
One prolific success story to emerge from
the Mac Futures incubator is British trader
Andy Priston. Priston was in his early
twenties when he became the first trader to
complete the Mac Futures prop training
program.
Nicknamed “Braveheart” for his bold
trading style, he is now considered one of
the most successful futures traders in the
business. Priston’s trading is said to account
for as much as eight percent of monthly
trading activity in the Eurodollar futures
contract on the Chicago Mercantile Exchange.
The 28-year-old reportedly earns as much as
$15 million per year and recently appeared
in the annual Sunday Times list of richest
Brits. He was helping Refco Trading services
set up a new shop in Montreal, Canada when
Refco went bust following a financial scandal
involving its CEO (see related story in this
issue). Man Financial bought the company
and offered Priston a job, but the trader
turned it down in favour of starting a new
prop trading office in Montreal with some
former Refco employees.
The story of this unique trader has
inspired countless others to try and
duplicate Priston’s success by entering the
training program of their local prop shop
and gaining the chance to prove themselves
on the front line of a proprietary trading
department. Greaves says opportunities for
young people interested in getting started
in trading have never been better, thanks to
the prop shop model.
Thinking Man’s Game
Trading Rooms are certainly a good deal for
many traders, but they are not for
everybody. Some prefer the privacy of their
own home or the seclusion of a small quiet
office. This does not mean that these traders
must go without the benefits of group
dynamics. One organisation catering to
clients looking for sophisticated online
market participation is thinkorswim.com
Thinkorswim is an organisation of
Chicago option traders who offer an online
training experience, totally unique in the
business. The focus here is on the analysis,
execution and management of complex
option strategies. Clients not only benefit
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23
 INSIGHTS
services which includes automated trade execution - they also get
to observe and interact with real pros in action, as they analyse and
comment on the current market, select and evaluate potential trades
and finally execute and manage chosen strategies. Clients can
participate in any of the trades by simply switching on the automated
trade allocation feature in their brokerage account.
Thinkorswim’s Tom Preston says the online classes were created
to meet demand for live, online seminars run by real traders that allow
participation in complex trades as they unfold in real time. “Clients
are able to take part in the live trading sessions from anywhere in the
world using our web streaming technology. Using the audio feature,
they can listen in as we discuss markets and trades we are looking at.
A chat feature allows us to interact directly with clients.”
Trades are posted so participants can see exactly how the positions
are constructed. All clients are kept current on the status and performance
of each position with regular updates. The thinkorswim team specializes
in complex option strategies such as calendar spreads, double diagonals,
unbalanced butterflies and iron condors to name a few. The emphasis is
on how retail traders can harness the practical experience of professional
option traders, with defined-risk, non-directional positions, creating a
portfolio with pre-defined market exposure.
Hands off Trading
Another brokerage service gaining in popularity, mainly in the United
States, is something called system assist. It caters to traders looking
for a totally automated trading approach that does not necessarily
require their presence. Typically the arrangement works as follows.
A client selects a trading system that he wants to have traded. He
then selects a broker who specializes in system assisted trading,
providing the technology and account management needed for
automated trading. Simply put, the system is then “turned on” and
the trades it generates are automatically allocated to the client’s
account.
New in Europe
System assist is relatively new in Europe. Michael Schricker of CTS
Brokerage in Plauen, Germany says customers need to thoroughly
research the systems they select for trading. He says there are
absolutely no guarantees a system will perform according to
developer claims. Not even the results from independent system
testers can be relied on completely. Schricker says users must
conduct walk-forward testing before allowing a system to trade real
money. He also emphasizes it is important the broker not be involved
in the sale of the trading system. “Any legitimate arrangement does
not involve sales or profit sharing agreements between the
developer and the broker. The client rents or purchases the system
from the developer and the broker provides execution and account
management. Anything else is a conflict of interest.”
System Portfolio
Strategies for implementing automated systems also vary. Users can
monitor the system in real time or simply turn them on and go about
their business, reviewing results at the end of the day. Another
strategy is to use a portfolio of systems designed to take advantage
of various types of market conditions in an attempt to smooth the
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account’s equity curve. There are a large number of system
developers offering either so-called black box systems or open
source systems. The workings of a black box system remain the
private domain of the developer and customers are prevented from
seeing exactly how the system works. With open source, the system’s
programming code is available for all to see.
Help in selecting a system is available through FuturesTruth.com,
a trade journal and website dedicated to evaluating a multitude of
systems currently on the market.
Innovative Trading Products: CFDs and Spread Betting
Yet another way brokers have gone about developing new business
is by specialising in innovative trading instruments. Britain has seen
an explosion in two new areas of trading; namely CFDs and Spread
Betting, spawning a whole new brokerage industry. A Contract for
Difference (CFD) is a cash settled trading instrument designed to a
mirror a specific underlying market. CFDs exist for just about any
financial market you can think of, from equity index futures and
stocks, to markets for treasuries, metals, energies and grains. CFDs
got their start when British institutional traders demanded products
that could be easily traded either on the short or long side, providing
fast and efficient market participation at low cost. The trend quickly
reached the retail level where small investors took advantage of the
low margin cost and small contract size. Small traders can use CFDs
to gauge position size easily to fit their accounts while still
participating on a one to one basis with the underlying market. A
recent improvement to the CFD market has been the introduction
of listed CFDs, which provide more security for retail customers. It is
estimated that there are more than 100,000 CFD traders in the UK
and volume turnover in the instruments has reached levels of more
than 80 billion Euros per year. The broker CMC Markets is one of the
biggest providers of CFDs offering contracts on a many as 1000 different
securities in 18 international markets
What’s Your Wager?
Another UK favourite, especially for small investors, is the new market
for Spread Betting on financial instruments. Here clients with as little
as a few hundred Euros can “trade”¨ the Dax future, gold future or
crude oil futures to name just a few of the available markets.
Specialised Brokers are the market makers for these new products
and business is booming. Even established traders are looking at
spread betting as a potentially more efficient way to participate in
certain markets. There are no trading- or exchange fees to pay,
spreads are narrow and trade execution fast. What’s more, Spread
Betting profits are tax free for British residents. Finspreads.com or
easy2spreadbet.com are just two brokers with the latest in this up
and coming market.
Summary
This is only a sample of the current innovative trend in the brokerage
industry. Traders and investors will continue to benefit from
decreasing costs, new technologies, fresh trading instruments and
valuable services helping them accomplish their market goals - now
and in the future.
February 2006 www.traders-mag.com