Having works in the different sectors of the financial industry, I think this will qualify me to give a few comments on the broker industry.
[B]Price spreads[/B]
Ten years ago working as a broker in the forex market was easy money, because you can quote spreads as wide as 10 points to institutional clients and clients are still coming back to you. This is comparable to arbitrage profit of 8 points as you can close off your trade in the inter-bank market at much lower spreads. Say your customer place a USD 10 million order, that is a risk free return of 0.0008 x 10 million = US$8000. That is because forex quotes are not widely available then, so customers just take whatever rate that their broker is quoting to them.
With the invention of internet, all customers, including the retails customers are able to see the forex spreads on the internet. As a forex broker, if you quote them a price spread that is wider than the average, they will ask you “Do I look like an idiot to you”?
10 years ago I would not be able to imagine that I can trade forex myself at home using only US$1000 as my capital, but that’s what a lot of retail traders are doing that now.
[B]Customised products[/B]
Currently if you want to trade crude oil in the futures market, most likely you will be calling your broker to buy oil futures from Nymex exchange. Crude oil futures is a very huge contract, value of 1 point is US$1000, a lot of retail customers are not able to stomach this kind of risk. Say you buy 1 lot of oil futures at $135 and if the market goes against you by $5, your unrealised loss is US$5000. US$5000 is a few months’ salary to a normal employee.
Since most online platform looks identical and serves the same function, one of the ways that they differentiate themselves is product innovation. Since Nymex crude oil futures contract is too huge, they have customised normal oil contract into supermini oil contract, whereby value of 1 point is only US$100, which is very affordable to most people. This has thus attract small investors to trade futures as well.
[B]From placing orders via phones to placing orders via online[/B]
10 years ago floor trading is common in a lot of exchanges. Customers have to pay high commission rate to brokers in order to get their order filled on the trading floor, and at that time many floor traders were receiving more than $10,000 a month salary while they were still in their 20s. Today a lot of trading floors all over the world had closed down and turns electronics. At that time customers placed their order via the phone.
With the use of internet many trading platforms are created. If you insist on doing your broker business using phone, then you face the risk of going obsolete in future. This is because by having an online platform, customers can view live prices, use the charting function, read news update and tracks the next big news using the events calendar provided.
As for voice broker what service does they get? Did I hear you say advisory services? If brokers are good at giving advisory services, wouldn’t they be trading on their own, why would they want to become a broker in the first place? If you are a customer which one would you prefer, an online broker or a voice broker? I certainly prefer an online broker.
[B]Commission rate[/B]
To become a broker is one of the most high-paying job 10 years ago, at that time many brokers are driving luxury cars and living in expensive property. But with fierce competition, identical products and services offered, one of the ways to attract more customers is by lowering their commission rate.
We are in the commodity boom era now, many have perceived that being a commodity broker is a great job to be in. This may not be true, commodity boom actually attracts more supply of commodity brokers into the market and pushes commission rate down.
When I was a commodity broker, the big customers (mostly are listed companies) are always being poached by many brokers offering lower commission rate. Then the customers will reflect that to us and ask if we can match the same commission rate offered. If you want the customer you have to lower down your commission rate to satisfy the customer, or else you will not likely to hear from them again.
Many online platforms had already waived off commission for their products, earning revenue from either the spreads or taking opposite sides of customers’ position. Would you rather pay low commission or no commission?
[B]No expiration date[/B]
Commodities have backwardation and contango built-in due to their nature. Commodities futures contracts have expiration date. Traders need to know in the event that the contract expires and a rollover is required, do the traders earn or lose contango spread as a result. Since commodities futures contracts have expiration date, traders need to know in the event that the contract expires and a rollover is required, do the traders earn or lose contango spread as a result.
For a contango product, say gold, near term price is lower than far month price; so if the trader has a long position in gold that is expiring, he will lose contango spread when he rollover his current contract to the next month.
On the other hand, if the trader has a short position on gold that is expiring, he will gain contango spread when he rollover his current current to the next month.
However the concepts of backwardation and contango are not easily understood by retail customers. To solve this problem some online platforms have provided contracts that do not have expiration date, so this will mitigate the problem of rollovers.
[B]Trust in online platforms offered by foreign companies[/B]
Currently one of the issues that most retails is concerned is the trust worthiness of the platform providers, as they need to deposit huge sum of money into the platform company before they can start to trade. These companies usually come from US and Europe.
With the use of internet, these platform providers do not have to register with the countries’ authorities in order to sell their products to the customers in these countries, because anyone who has internet connection from any parts of the world can have access to those platforms and will be able to open accounts with them.
I believe as time goes by, the trust by retail customers will grow as online trading becomes more common, and platform companies will try to gain recognition by register themselves with some reputable government authorities in order to gain confidence from the investment community.