In the last episode, we discussed the problem of not knowing anyone to invest with your CTA. This week we discuss what to do when you know people who want to participate in your trading program, but you think they’re not suitable to invest. We also discuss the customer suitability rules applicable to registered CTAs, and why writing your own more stringent rules about suitability hurts your profitability.
Welcome to The Profitable CTA, the only podcast that helps commodity trading advisors grow their businesses and boost their bottom lines. I’m Kelly Hollingsworth and I’m very glad you’re here because CTA profitability is suffering, and in this show we talk about how to fix that. In every episode, we discuss a common problem that undermines CTA profitability, and this week we’re going to continue working on the biggest problem for CTAs and their profitability, and that is finding and attracting customers.
Last week we talked about the very common and largely illusory problem called, “No one I know is in a position to allocate to a CTA.” Today we’re going to discuss this problem’s very close cousin, and it’s called, “No one I know is suitable to open an account with a CTA.”
The first thing we’re going to do today is clarify why these are two different problems. They are related, but they’re not identical. Then I’ll give you the overview on the suitability rules that apply to registered CTAs, and then we’ll discuss why some CTAs reject suitable customers, and how this unnecessarily hurts their profitability, and what you can do to avoid these problems.
What’s the difference between “I don’t know anyone” and “I don’t know anyone who is suitable”?
The first thing I’m going to touch on is what’s the difference between “I don’t know anyone” and “I don’t know anyone who is suitable”?
When you think you don’t know anyone, this means you literally don’t know anyone, or the people you know, you think it’s impossible for them to open an account for you to trade.
When you think you don’t know anyone suitable, it is possible for people you know, or at least one person, to open an account for you to trade (often, they want you to trade for them), but you’re reluctant because you think it’s the wrong thing for them to do. In regulatory-speak, you think they’re not suitable to invest in your trading program.
What are the rules regarding customer suitability?
The first thing to do in a situation like this is separate the actual rules that govern CTAs regarding suitability from the imaginary rules about suitability that might be floating around in your head.
As a backdrop to this discussion, the first and perhaps most important thing I can tell you about entrepreneurship is that struggling entrepreneurs restrict their operations and their profitability based on imaginary rules that they’ve written in their own heads, that don’t actually apply.
CTAs aren’t unique in this regard, by the way. After 2 ½ decades of working with entrepreneurs, I can promise you that their struggles and failures are largely if not fully based on the made-up rules in their heads. This is all entrepreneurs. They have these rules in their heads that hold down their profitability for no reason other than, the entrepreneur believes a constraint exists that really isn’t there. Why does this happen? We’ll get to that in a second, we’ll talk about why particularly CTAs want to operate under more stringent suitability rules than actually exist, but first let’s look at what the rules actually are, because NFA and the CFTC don’t set restrictions on suitability. This may come as a surprise, especially if you hail from the investment adviser world. For traders of securities, meaning investment advisers who operate in the SEC-regulated world, there are suitability constraints. This is why, if you trade securities futures, which are a hybrid instrument, you will see a suitability requirement applicable to what you’re doing.
But if you trade futures or forex contracts that don’t have their foot partially in the securities world, it’s different. NFA Compliance Rule 2-30 governs CTAs and the circumstances under which they can take on a customer. It’s commonly called the “Know Your Customer” Rule, because the rule basically requires you to obtain certain information from your customer before you can begin trading for them. Securities futures excepted, there are different requirements for those in this rule, but when you take out securities futures, the rule says that you must get enough information from your customer to have an understanding about the type of risk disclosure that’s reasonable for them to make an informed decision about whether to move ahead or not.
The theory here is that if you’re dealing with a billionaire investor who’s run his own CTA and traded futures contracts for his own account and customer accounts for decades, that prospective investor requires a different, lower level of risk disclosure than someone who doesn’t have that kind of money or that kind of experience.
What’s important to notice about the rule, though, is that unless you trade securities futures products, there’s no requirement to refuse a customer. This is important so I’ll say it again. There’s no requirement for you to refuse a customer based on suitability, unless you’re trading securities futures products for that customer. What the rule requires you to do is to get information about the customer’s background, age, income, and net worth, and you provide risk disclosure that’s appropriate. It is not on you to determine if the customer is suitable and to refuse his or her account if you decide that they are not suitable. That’s how investment advisers have to operate. Your job as a CTA trading non-securities futures products is to provide adequate risk disclosure for the circumstances. If the customer decides to proceed once he or she has been informed of the risks, the regulators, NFA and the CFTC, are under the impression that it’s okay for him or her to proceed if he or she wants to.
So this is interesting, isn’t it? In the minds of the futures regulators, if the customer knows what’s up in terms of risk, it’s up to the customer to decide if this is right for them.
Your feelings about customer suitability reveal your (business-killing) thoughts
So now you may be wondering, why does this matter? Why am I talking about this? I’m not suggesting that you take the freedom that this rule provides to most CTAs, i.e. those who don’t trade security futures, and go out and solicit cash-strapped widows and orphans of the world to start speculating for them.
Rather, I’m discussing suitability because when CTAs think their prospective customers aren’t suitable, there’s one of two things going on. One, the customer truly is unsuitable and has absolutely no business allocating to a CTA because he or she has no money and no risk tolerance, or more likely, the second option is that the customer is fine in terms of the willingness and ability to afford the risk, and they want the profit potential of what you do, but it’s the CTA that has some business-killing thoughts spinning around in his head that make the CTA want to reject the customer even though the customer would be fine participating in your trading program. This latter scenario is by far the most common, but either one of these could happen, so let’s look at each of these in turn. Let’s divide and conquer.
In scenario one, where the customer has no money and no risk tolerance and no business allocating to a CTA, what I’ll say about this situation is that it’s rare. It’s rare that a CTA would have to refuse a customer like this. Why? Because these folks who have no money and no risk tolerance and no business allocating to a CTA pretty much aren’t lining up to do that. They just not going to approach you, and if you approach them or for some reason a discussion about them allocating to you does develop, they’re going to shut it down and say that it’s not for them. They’ll come right out and tell you that they can’t afford this kind of investment and it’s just not for them. As I said earlier, this is rare but it could happen so now we’ve addressed it. When it comes up, in all likelihood, it’s going to go away with no effort from you.
What happens way more often than not, in terms of suitability, is that before there’s even been a discussion about what the customer wants and could afford and is interested in, the CTA decides in advance that “no one I know is suitable for this.” In cases like these, it’s not about the customer and what his situation actually is, and if it’s not about the customer, who is it about? It can only be about the CTA.
One thing that commonly happens in these cases is that the CTA is operating under assumptions, often erroneous assumptions, about who has money and who doesn’t. Did you read the Millionaire Next Door? The people with the most money often look like they have no money. This is why they have money. They don’t blow it leasing late-model Lamborghinis. So this is a great reason to take the approach that the futures regulators extend to you, and allow your customer to rule himself or herself out if it’s not for them. In other words, let your customers count their own money and assess their own risk tolerance. They’re in a far better position to do this than any CTA is.
But the more important thing to look at here is why a CTA would be tempted to assess a customer’s suitability for him or her, and reject a customer even though the customer may be begging to be allowed into the trading program. The motivation to do this can come from pure altruism, or what feels like pure altruism. The CTA is simply acting out of pure concern for the customer, and the question here is, is denying an opportunity to your customer an altruistic act? If your customer wants it, how altruistic is it not to let him or her have it?
This reveals that there’s typically something else is usually going on, besides pure altruism, in a CTA’s desire to reject certain customers. What is this “something else”? It’s the CTA’s desire to avoid negative emotion. When CTAs who reject perfectly suitable customers say, “I don’t want them to lose money,” almost always there’s a desire to avoid feeling something on the part of the CTA if the customer loses money. Maybe it’s anxiety during the trading day. Maybe it’s guilt if there are losses. Things like that.
This desire to avoid negative emotion by limiting one’s business prospects is an epidemic problem in the CTA world. So many of you very talented futures and forex traders are sitting on the sidelines trading your own accounts and not getting in the CTA game at all because you just never want to feel bad at the idea that someone might lose money. For those of you who are in the game, the desire to never feel anxious or guilty has you doing things, unprofitable things, such as confining your universe of potential customers to jaded institutions who barely deign to look at you and who give money to maybe one out of the thousands of CTAs who approach them for money. In short, the desire to avoid anxiety and guilt and other negative emotions is hurting the CTA industry generally, by keeping talented traders out, and it’s hurting individual CTA profitability, by keeping mainstream customers out of their trading programs. If you’re a great trader with your own trading account, you’re trading very profitably for yourself, but you’re not killing it with a CTA business, I can almost promise that you have at least some of this desire to avoid negative emotion going on.
So what can be done about this? The first thing is to take a look at where these unpleasant emotions come from. We think it’s from the loss. We think, if there’s a loss of course I’m going to feel anxious and guilty and terrible. But there’s actually something else going on. It’s not the loss itself, but rather, it’s what we make the loss mean.
To illustrate what I’m talking about, let’s consider an example outside of the CTA business in which we as a society are right now fairly drowning in a sea of negative emotion. Let’s consider the emotional response to “The Wall” between the U.S. and Mexico that Donald Trump wants to build and Nancy Pelosi and her fellow democratic colleagues don’t want built. Some people are 100% in favor of the wall. Some are 100% against. It doesn’t matter which you are or which I am—this show is politically agnostic because CTAs can make money in all political environments. The point here is to look at why are some people angry about the idea of a wall and some people thrilled? The difference in emotional response, feeling anger vs. feeling thrilled, is because of what they make the wall mean. In other words, what we’re variously thinking about the wall. If you’re thinking, the wall is a senseless, racist persecution of vulnerable people for no good reason your feelings, your emotional response to the wall, are going to be very different than if you’re thinking the wall is a sensible solution to the problems caused by a porous or penetrable border. Some people aren’t even concerned about the wall. They have no emotional response to the wall, because their thoughts are along the lines of they’re either going to build a wall or they won’t. Either way, it’s out of my control and it doesn’t really affect me.
So there are two important things to notice here: one, it’s the thoughts about the wall, the meaning any given person attaches to the wall, and not the wall itself, that causes the emotion, whether positive, negative, or neutral. Two, and more importantly, the meaning that we attach to the wall, the thoughts we are thinking about the wall, are optional. And this means the emotional response that is generated by those thoughts also is optional.
We tend to not think this way. We tend to speak about our mental and emotional lives in terms of our lack of control over them. For example, people who are raised in a politically conservative or liberal or agnostic family, tend to adopt the views and thoughts of those around them, and later on as adults they ascribe those thoughts to their personality or a fixed aspect of themselves that they can’t change. This is why we often say things like, “I wasn’t raised to believe that,” or “It’s just not my personality to do something like that.”
But in actuality, our thoughts about border walls, trading losses, and everything else, for that matter, are not fixed. Whatever you’re thinking about any given circumstance is really just a sentence that’s running through your head, and those sentences generate an emotional response in your body when you think them. A thought is just a sentence that runs through your brain. If it’s a belief, it runs through your brain on a loop, but however frequently you think a thought, you can rewrite that sentence or delete it any time you want to. For example, our politicians could change their thoughts about the wall at any moment if they wanted to. This isn’t unheard of, by the way. Anyone, politician or otherwise, who has one position on the wall could see a human-interest story that cuts against their view and completely changes their minds. They can do a 180 on the wall, or anything else for that matter, simply by deleting one thought, one sentence that’s running through their mind, and writing another. Personality and genetics and the way you were raised have nothing to do with this. It’s all about what we think about the wall in this moment, the sentence we’re currently writing in our heads, that affect how we feel about it, and that can change on a dime.
So what can we glean from this that can help us with CTA profitability? It’s not the losses that make a CTA feel guilty. It’s not that a particular person you know suffered losses that makes a CTA feel anxious. Rather, it’s the CTA’s thoughts about the losses or the person who suffered them that make a CTA feel guilty or anxious, and those thoughts are entirely optional. In other words, it’s possible for any CTA to trade for customers and not feel guilty if they incur losses. It’s possible for any CTA to trade for customers just as they do for themselves, and never feel anxious.
So here’s what I have for you today: If you are a CTA who is sitting on the sidelines, not getting fully in the game, or not getting in the game at all, because you don’t want to feel pressure to trade differently, you don’t want to feel anxious about the way you trade, you don’t want to feel guilty if there are customer losses, what I want to offer to you today is all of those emotional responses are 100% optional because they’re all based on the thoughts you’re thinking about the situation, and not the situation itself.
The idea of not feeling guilt or anxiety about trading losses can feel reprehensible to some CTAs. They think it means they are bad people or unethical people who don’t care about their customers. But this, too, is a thought, and it’s a thought that doesn’t serve CTAs, because when emotion, particularly negative emotion, runs high, intelligence tends to be is low. This is why a guilty CTA or an anxious CTA is typically a dangerous CTA. I don’t think I’m going too far out on a limb here when I say that if you feel really, really guilty or really charged up and anxious about trading losses, whether actual or losses that you might incur someday, the likelihood of recovering those losses in subsequent trading is probably low, and the likelihood of suffering those losses is probably high. If you approach trading losses with a sense of calm, purposeful focus, you’ll probably have a much different experience.
So here again, I want to clarify: the point of today’s episode on customer suitability is not that it’s terribly important whether you manage money for this customer or that customer or you don’t. That just doesn’t matter. The reason I’m talking about suitability today, and how CTAs feel about suitability, is because it illustrates what is terribly important, and that is that you manage your mind so that you don’t unnecessarily reject completely suitable customers, and you don’t unnecessarily forego business and trading profits.
What do I mean by manage your mind? When you manage your mind, you do two things: One, you are aware that it’s your thoughts, not the circumstance of a loss or a particular customer suffering a loss, that generates your emotional response. And two, you also select the thoughts that will generate the emotional response that serves you best in any given circumstance. For example, if trading from a place of calm, purposeful focus tends to generate profits for you, and I imagine that it would, doing thought work can help you create that emotional state for yourself in every circumstance—whether you’re up or down or flat at the time, whether things are going your way on a trade, or they aren’t.
If managing your mind to increase your trading and business profits is something you’d like to learn more about, get in touch. firstname.lastname@example.org., because I’m not just a lawyer. I’m also certified in a school of causal coaching in which I received training to help you learn to manage your mind so that you can trade better, grow your CTA, and earn more. You can contact me by email, or you can also set up a free consult with me at profitablecta.com. Go to the website, you can access my calendar and set yourself up with a session. I look forward to hearing from you if you’d like some help with your CTA, and I look forward to connecting with you in the next episode. And last, please don’t take what we discuss here as legal advice. I can only give you legal advice if you actually hire me as your lawyer. Thank you and I’ll talk to you next time.