Proprietary Trading: What Is It, Best Prop Firms

What is Prop Trading? 

Proprietary trading (also known as prop trading) traditionally refers to when a financial services company – either a bank, a Broker, or a fund – engages in trading activity using its own money, thus aiming to profit from direct asset valuation rather than commissions or other customer-related fees. 

Traditional prop trading firms typically employ licensed, professional traders who the firm employs on a fixed contract. However, in the last decade, a new type of prop trading emerged that allows virtually anyone to join the industry and benefit from it – Modern Prop Trading. 

Modern Prop Trading or Traditional Proprietary Trading?

Modern Prop Trading companies are looking for traders who, typically after passing a certain evaluation phase, can get access to a so-called funded account, from which the trader can then withdraw their profits.

The key advantage of Modern Prop firms is that virtually anyone can trade with them (no license or previous track record is required) and the client can trade without risking his own capital. The offered range of asset classes is usually wide, just like with retail CFD brokers. Clients can trade anything from Forex to Indices, Commodities, Stocks, Metals, or Cryptocurrencies. 

What is a Prop Trading Firm?

A proprietary trading firm, or prop trading firm, traditionally involves financial services companies using their own money to trade and profit from direct asset valuation rather than customer-related fees.

Modern Prop Trading firms typically include an evaluation phase during which the client has to prove their trading skills by meeting certain criteria set by the company. There is usually a fee the client has to pay to enter the evaluation, however, it is often refunded later with the first payout. Based on the client’s results, the client can then access a demo account and withdraw his profits (the firms usually take around 30-20% of the profits made by the client for themselves).

Traders at prop trading firms closely follow market trends and volatility to capitalize on price movements quickly. Risk management is key as the firm’s funds are at stake if trades result in losses instead of gains. Many prop trading firms have a short-term, high-frequency focus to benefit from intraday price fluctuations.

Some Modern Prop Trading firms copy the trades made by their clients at their own discretion on their live accounts. It is important to note that clients of Modern Prop Trading Firms do not get direct access to a live market. As you do not need any license to trade with these companies, they have become widely popular among retail traders.

How Does Proprietary Trading Work? 

Proprietary trading, or prop trading, operates under a straightforward yet complex principle; a financial firm trades stocks, bonds, currencies, commodities, and other financial instruments using its own money, rather than the capital of clients. This approach enables the firm to retain full profits from its trading activities. 

Traders at prop firms use a variety of strategies, including statistical arbitrage, market-making, and global macro-trading, to exploit market inefficiencies and volatility. The firm benefits from these activities by capitalizing on short-term price movements and trends. Essentially, prop trading is the firm betting on its ability to outsmart the market through superior strategies and risk management techniques.

Types of Prop Firms 

Modern Prop Firms

Modern Prop Firms allow almost anyone to join. After you pay a fee, you will be allowed
to an evaluation phase, and after successful completion, you can get access to a funded
account from which you can then withdraw your profits. However, you are not employed
by the company and you are not connected directly to the live market and the company
is not regulated by traditional regulators.

Traditional Prop Firms

Traditional Prop Firms are much harder to join. In order to trade for such a company, you
typically need to be a licensed trader with a proven track record. If the company decides
to accept you, you will be employed by the company with a fixed remuneration plus
performance bonuses. Traditional Prop Firms trade with their own capital and are
regulated.

Independent Prop Firms

Traditional independent proprietary trading firms operate without being attached to a larger brokerage. They have complete autonomy over their business model. Traders are given a portion of the company’s funds to actively trade markets on the firm’s behalf. 

Brokerage-Based Prop Desks

Traders at these “prop desks” are employees in a brokerage house who act as principals using the broker’s capital. Resources like analytics, data feeds and infrastructure are typically provided. Successful traders may generate income for both themselves and the broker. 

Prop traders can elect to work with either independent, self-funded firms or brokerage-based prop desks depending on their risk tolerance for strategy restriction. Both models thrive by cultivating talented quantitative or discretionary traders.

Best Prop Trading Firms: By Asset Types

Forex Prop Trading

Prop trading firms can specialize in currency trading, leveraging the firm’s capital to profit from fluctuations in exchange rates. These firms provide traders with the technology and support needed to trade global currency markets. 

Futures Prop Trading

Futures trading prop firms focus on buying and selling futures contracts across commodities, financials, and indices, using the firm’s capital to speculate on future price movements. They equip traders with advanced tools and strategies to navigate the futures markets, emphasizing risk management and leveraging market trends for potential profits.

Stock and Options Prop Trading

Stock and options prop trading firms engage in buying, selling, and trading equities and their derivatives, utilizing the firm’s resources to capitalize on stock market volatility and options strategies. They offer traders the technology and support to execute complex trades, aiming to profit from price movements and options valuations.

Prop Trading Firms for Swing Trading

Prop trading firms focusing on swing trading capitalize on short to medium-term price movements, leveraging the firm’s capital to execute trades over days or weeks. They prioritize analytical tools and market insights to identify trends and reversals, providing traders with the strategies and support needed to profit from volatility in various markets.

Crypto Prop Trading

Many prop trading firms specialize in cryptocurrency markets, using firm capital to trade digital assets like Bitcoin and Ethereum. They leverage market volatility and technological advancements to execute trades, aiming to profit from rapid price movements.

Prop Trading Strategies 

Proprietary trading strategies encompass a wide range of techniques employed by traders to capitalize on market opportunities, each with its unique risk profile and expertise requirement. 

Pros and Cons of Prop Trading

Pros

• Not Risking Your Own Money: While trading with a Modern Prop Trading firm, clients trade with fictitious funds and hence do not risk their own money.
• Access to Advanced Technology and Research: Prop trading firms have sophisticated tools and research capabilities at their disposal.
• Premium Programs: Some companies offer premium programs for consistent
  traders to increase their account size.

Cons

• Slower Payouts: Contrary to retail brokers, which let you withdraw your profits anytime you want, Modern Prop Trading firms require you to wait up to a few weeks for a payout.
• Skill and Experience Requirement: Prop trading demands a high level of technical and emotional skills, with a steep learning curve for new traders.
• Regulatory Challenges: The regulatory environment for prop trading can be
  complex, affecting operational freedom and profitability.

Balancing these pros and cons is critical for firms and traders navigating the volatile world of proprietary trading, requiring a careful approach to strategy development and risk management.

Proprietary Trading Firms for Beginners

For beginners, prop trading firms might seem like a high-stakes puzzle. Essentially, proprietary firms trade in financial markets using their own capital, not the capital from clients. This setup allows them to make bold moves and pursue profits more freely. 

Beginners should understand that these firms specialize in various trading strategies, from high-frequency trading to global macro-economic plays with the help of sophisticated technology and in-depth market analysis. For those looking to get started, it’s crucial to start with a solid foundation in market principles and a keen sense of curiosity.

How to Choose a Prop Trading Firm 

Evaluating all the different prop firms out there can certainly be tricky, particularly if you are new to this world. But worry not: we’ve got you covered with a few simple steps:

1. Assess the Credibility of the Firm

Firstly, do your due diligence, check the reviews online, and see which firms have the most positive reviews.

Next, scrutinize the companies’ track records meticulously, paying particular attention to their ability to provide consistent liquidity across various market conditions.

If the firm has hit the market a little too recently or experienced severe financial problems during the last bear market in 2022, that’s a red flag.

2. Evaluation of Senior Traders

Secondly, it’s crucial to evaluate the experience and reputation of the company’s senior traders, as they will be instrumental in shaping your learning journey and guaranteeing the company’s long-term stability. If a company has no information whatsoever about who are the people on its team, that’s yet another red flag.

3. Analysis of Strategies and Products

Thirdly, delve into the different strategies and products offered by each firm to identify which aligns best with your strengths and objectives. Not necessarily the company you find best in general will prove to be the best for your personal skills and asset familiarity.

4. Comparing Firm Features

Next, compare factors such as access to proprietary technology, available funding amounts, and the structure of bonus incentives to determine which firm offers the most advantageous terms for your goals.
Understanding the costs associated with the monthly membership, the withdrawal fees, and the implied risk-reward offered by a given company is also key.

5. Understanding Costs and Risk

Additionally, verify whether the firm prioritizes risk management through initiatives such as stop-loss education, which can significantly impact your trading success.

6. Take a Free Trial

Most of the Modern Prop Trading firms offer a Free Trial account. Compare the Free Trial accounts and see which company offers the best spreads, lowest commissions, and the symbols you plan to trade.

7. Mentorship Opportunities

Don’t hesitate to inquire about the availability of ongoing mentoring opportunities, as mentorship can greatly accelerate your learning and growth as a trader.

8. Performance Review and Feedback

Lastly, review whether the firm conducts regular performance reviews to provide constructive feedback and opportunities for skill enhancement.

Prop Trading vs Hedge Funds

Prop trading and hedge funds both involve speculative investing with the goal of profits, but there are key distinctions. 

Prop traders use a firm’s own capital to trade actively, assuming full risk and reward of the positions. Hedge funds manage money on behalf of clients like high-net-worth individuals and institutions. They also use leverage and various trading strategies. Proprietary traders can take on greater risks since it is not other people’s money. 

While hedge funds think in terms of years and resilience, prop traders thrive on the market’s daily adrenaline rush, making swift moves to capitalize on short-term opportunities. Both aim for profit and require exceptional analytical abilities to exploit market opportunities, but their paths and playbooks differ vastly.

Proprietary Trading FAQs

How Is Prop Trading Different from Other Forms of Trading?

Prop trading operates on the firm’s own capital for swift gains, distinct from hedge funds’ long-term investor strategies and retail traders’ personal capital ventures. This approach allows prop traders to leverage significant resources and expertise.

How Are Modern Prop Firms Different From Brokers? 

When trading with a retail broker, traders make a deposit and manage their own money. Traders risk their capital. While trading with a modern prop firm, the trader does not trade with his own money and hence does not risk it. However, there is an evaluation phase and the withdrawals become available in up to a few weeks.

What Qualifications and Skills Are Required to Become a Successful Proprietary Trader?

Successful proprietary traders require a blend of quantitative analysis, market intuition, and risk management skills. They thrive under pressure and embrace continuous learning, followed by advanced degrees in finance or related fields.

How Do Proprietary Trading Firms Manage Risk?

Proprietary trading firms closely monitor risks through tools like stop-losses and position size limits to prevent large losses on any single trade. Prop firms also emphasize portfolio-level risk management by diversifying strategies and maintaining properly hedged positions.

What Regulatory Considerations Govern Proprietary Trading Activities?

Traditional prop trading firms must comply with securities regulations set by agencies like the SEC regarding proper capital requirements, reporting obligations and market conduct rules. They also follow rules to prevent illegal activities like insider trading or market manipulation.

Modern prop trading firms, as they do not connect traders directly to the live market, do not undergo any such regulation, contrary to retail brokers or traditional prop trading firms.

Be sure to check out our other prop trading guides for more in-depth strategies and insights to boost your trading success.