Prop Trading

Prop trading, short for proprietary trading, refers to when firms use their own money to invest and trade rather than investing on behalf of clients. Several popular prop trading firms also allow traders to trade with the firm’s money, sharing profits and giving traders access to more powerful trading tools.

Two types of prop trading firms exist – independent prop firms and brokerage prop firms. Independent firms do not have clients, whereas brokerage firms operate a prop desk within a brokerage firm. Successful traders can apply to trade on behalf of these firms, often earning up to 50% to 90% of the profit from trading. In this guide, we’ll answer the question, “What is prop trading?” and examine the pros and cons of trading as a remote trader for a larger firm.

How Does Proprietary Trading Work?

Proprietary trading involves using a trading firm’s capital to trade on the firm’s behalf rather than investing on a client’s behalf. The goal of trades is to earn profits for the firm as opposed to investing for clients to earn trading commissions. Prop firms often use a mix of their own in-house traders and individual contract traders who have passed an evaluation.

Prop trading firms can include independent trading firms or asset management firms. However, US banks cannot engage in proprietary trading due to federal regulations such as the Volcker Rule to limit risky investments by banks. The rule followed the Great Financial Crisis (GFC), which led to bailouts of more than $498 billion in the US alone, according to estimates.

Prop trading can occur at hedge funds, asset management firms, commodities companies, and small or independent trading firms. Although prop traders often work via contract, hours can be grueling, with workdays often reaching 12 hours or longer. Many firms focus on forex or crypto trades, both markets that never sleep.

Trading can reach well beyond traditional stock trades, including leverage trades, currencies, derivatives, bonds, and commodities. Trading technology often also includes sophisticated software not available to retail traders. Additionally, prop traders benefit from information that may not have hit mainstream market sources.

Prop traders receive access to trading funds that belong to the firm, otherwise known as direct funding. However, firms share a percentage of the profits, often as much as 50% to 90%. The exact commission amount may vary based on several factors, including trading history, with profit sharing defined in a contract once accepted as a trader.

Benefits of Prop Trading

One of the primary benefits of prop trading is access to trading capital coupled with advanced trading tools. Even the most skilled traders can face hurdles in the form of trading restrictions, such as the FINRA rule that requires day traders to maintain a substantial $25,000 margin account. Although designed for safety, this rule ties up trading capital and limits trading opportunities.

Prop trading offers instant access to trading capital, putting gifted traders in a position to earn substantial profits.

• Access to capital: Funding amounts vary, with beginning traders often receiving a few thousand in funding for trades, with an opportunity for larger funding amounts based on performance.
• Advanced trading tools: Prop funding firms typically offer advanced trading software and access to up-to-the-minute information that may affect asset prices.
• Training: Many prop trading firms offer additional training and simulated trading to hone your skills.
• Payment options: Earnings are paid regularly, often with a 14-day schedule, allowing you to withdraw your share of earnings in crypto or cash.

Prop Trading Pros and Cons

For traders, proprietary trading comes with both advantages and disadvantages. The notable advantages include access to trading funds and advanced trading tools. However, complicated rules and a tiered funding structure can make it difficult to move up to larger funding amounts.

Complex rules can make success with prop trading firms more challenging, and if you fail, you’re likely out of the program. Additionally, US traders face limited opportunities due to tougher restrictions.

Traders are also responsible for losses, which are typically bundled into a “loan” from the prop trading firm to the trader. Many firms also require a security deposit to trade larger amounts. Profits offset losses, but a few bad trades can start digging a deep hole. However, consistent traders who avoid emotional trades can earn impressive amounts and enter trades they may not be able to access on their own.

What Assets Can You Trade Via Prop Firms

Tradable assets vary by firm and, in some cases, by location. For example, fewer proprietary trading firms service US traders, limiting the types of assets available for trading. On a broad level, trading opportunities span a wide range of assets.

• Forex: Foreign exchange trading is a staple for many prop trading firms.
• Bonds: Trade government or corporate bonds.
• Crypto: Some firms now offer cryptocurrency trading due to higher volatility in trading markets.
• Stocks, Indices, and ETFs: Publicly traded stocks are available for trading, including short-selling inventory in many cases.
• Commodities: Trade oil, gold, or other commodities.
• Derivatives: Many prop trading firms also support futures trading.

Proprietary Trading Firms

Dozens of proprietary trading firms to choose from give traders an opportunity to match their skills to a firm’s trading program and earn more. Firms like the Overview Funding Program (OFP) make it easy to customize your own program. Others, like Trade The Pool, specialize in programs for US traders. Let’s look at some of the leading prop trading firms.

1. OFP Funding

OFP provides a customizable funding program with account sizes ranging from 5k to 200k. Choose your max drawdown and profit percentage split to calculate your account cost. OFP also offers a perk that increases your deposit by 25% if you’ve realized 20% gains in your first three months of trading.

Overview is a less structured program in that there are no challenges or profit targets. Additionally, purchasing a funded account is a one-time expense with no recurring fees. By comparison, many other programs require a monthly subscription.

However, payouts hinge on consistency. In effect, one great trade or blockbuster day can’t carry a balance of sub-par trades. The firm provides videos explaining trading rules with examples.

2. Trade The Pool

Popular with US traders, Trade The Pool provides access to $1 million USD in trading capital. What’s the catch? You have to qualify.

The platform offers a virtual trading platform to hone your skills for two weeks before entering the evaluation program. There’s also a cost to the evaluation, with differing fees depending on the program you choose. Each program has its individual rules, including max loss amounts and trading limits. Once you reach your profit goals for your chosen program, you’re in.

3. The5%ers

With a focus on training and four funding programs to choose from, The5ers has become a popular home base for prop traders. Stock trading, one of the four programs, directs aspiring traders to Trade The Pool, covered previously. Other funding programs include Bootcamp, Hypergrowth, and High Stakes, the last of which is the most challenging but possibly the most rewarding for exceptional traders.

Bootcamp allows aspiring traders to improve their skills as they trade and offers unlimited time to pass the qualification. This tier also lets traders boost their trading limits over time.

The5%ers prop firm focuses on forex trading, with stock trading available through Trade The Pool. Although forex trading can be more complex, the platform offers free webinars, as well as training, focused on trading plans and risk management to help keep your performance on track with goals. An in-house portfolio analyst provides free performance coaching based on real-world results to fine-tune your trading.

Conclusion

Prop trading has become a popular alternative to day trading and brings several advantages for talented traders. Access to larger amounts of capital and leverage lets traders capitalize on opportunities that may not be available when using a self-funded account. Additionally, traders often have access to sophisticated software and up-to-date news that retail traders often don’t have access to.

However, proprietary trading also brings some risks and costs, including evaluations or monthly fees for software access. In addition, traders typically have to deposit a sizable amount of money to cover losses, and if losses exceed the deposit amount, traders may become liable for amounts exceeding the deposit amount.

Several types of plan structures add to the complexity of prop trading, so it’s essential to study each program (and company) carefully before making a time or money commitment.

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