What Is a Commodity Broker?

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By Dave Guilford
eHow Contributing Writer

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A commodity broker is a financial services professional licensed to sell commodity futures and options contracts. Unlike a stockbroker, a commodity broker deals in physical commodities such as foods, metals, energies, building materials, agricultural products, currencies, and stock and bond futures. Commodity trading is regulated by the National Futures Association (NFA) and the Commodity Futures Trading Commission (CFTC). All commodity brokers must pass the Series 3 examination in order to be licensed. The Series 3 is a two and a half hour exam consisting of 120 questions covering options and contracts, futures theory, hedging, margin and settlements, analysis, CFTC/NFA rules, and customer accounts and orders.

Function

The function of a commodity broker is to handle customer accounts, enter customer orders and verify their execution, and report those executions back to the customer. A commodity broker also monitors margin calls, collecting funds from the customer when necessary. In the case of a full-service commodity broker, the broker also suggests and recommends trades to the customer based upon breaking news and the guidance of the brokerage firm's research department.

Types

The two types of commodity brokers are full service brokers and discount brokers. Both have passed the Series 3, are licensed, and are registered as Associated Persons (AP) with the NFA. The primary difference is in the level of service and the rate of commission. A discount commodity broker is employed to simply enter and verify the execution of customer trades and report those executions back to the customer. Discount brokers do not make recommendations to customers. As the term implies, the commission rate for a discount commodity broker is quite a bit less than that of a full service commodity broker. A full service commodity broker often teaches a customer about the commodity markets and makes trading recommendations.

Considerations

For novice commodity investors, it is a good idea to begin trading with a full service commodity broker. The broker may recommend beginning trading in commodity options rather than futures. While commodity options don't move point-for-point with their underlying futures contract, they do limit the potential downside to the amount invested in the option plus commissions and fees. If an options trade goes the wrong way, the investor will only lose the total investment. If a futures trade goes the wrong way, the investor can lose the entire investment and end up owing more money just to get back to a zero balance in the account.

Misconceptions

Not all commodity brokers are wild gamblers as they've been portrayed in movies such as Trading Places. Most are calm, thoughtful individuals who keep their clients' best interests in mind at all times. The NFA enforces strict ethics policies, and almost all commodity brokers take their fiduciary responsibilities very seriously.

Warning

If you are going to invest in stocks, use a stockbroker. Likewise, if you are going to invest in commodities, use a commodity broker. Do not risk your money with a broker that purports to be an expert in all markets, even if he does have the required licensing. The markets are much too volatile to invest with anyone less than a specialist in a given market.