Proprietary
Firm Trading is becoming more and more popular and widespread in the world.
Let's see what it is.
Reading Time: 5 minutes Financial activity: Trading Knowledge level: Beginner / Intermediate
Summary
What is a Prop Firm?
The challenge
Pros and cons of Prop Trading
Conclusions
What is a Prop Firm?
Officially, a Prop Firm is a financial institution that uses its capital
to trade financial instruments. This means that the firm is not trading on
behalf of clients, that are financed by the Prop Firm itself, but rather for
its profit.
So, how do Prop Firms work? Typically, Prop Firms have a team of
selected traders who are responsible for making investment decisions. These
traders use a variety of strategies to identify trading opportunities and once
a trading opportunity is identified, the traders will place orders to buy or
sell financial instruments using the money of the Prop Firm.
The challenge
The
challenge refers to the evaluation process traders must undertake to become
fully-fledged prop traders. This evaluation process is done on a demo trading
platform. To participate in this selection process, an aspiring prop trader
must pay a cash fee and the fee trader pays will be proportional to the amount
of capital the trader has access to (if successful).
And here my
doubts begin.
Passing the
test is usually very difficult due to several limitations:
- Time: traders will typically be given a set number of days to complete the challenge (for example, from 30 to 90 days), and they will automatically be disqualified if the challenge isn't completed within this time.
- Maximum loss: if a trader loses more than a specified percentage of the initial account balance (for example, it can range from 4% to 10%), he is immediately disqualified.
- Maximum daily loss: if traders lose more than a specified percentage on a given day, they can also fail the challenge.
- Profit target: a trader must prove his capabilities to reach a profit target (it usually ranges from 5% to 10%).
- It is also sometimes forbidden to keep trading positions open on weekends or public holidays.
- There are limitations to the assets you can trade, too.
As you can
see, passing the challenge is very hard, and I suspect that Prop Firms generate
a great number of their profits from this fact, that is, I think the business
model of the Prop Firms is based on the money that traders pay to participate
in the test.
Of course,
some traders are still good enough to pass the challenge. Very well! Nothing
prevents you from giving them the money lost by the traders who have failed the
selection test as funds for real trading, and then sharing the earnings!
If a
selected trader, operating on the markets, does not maintain the required
standards in terms of loss and profit, he is immediately deprived of the money
made available by the Prop Firm.
In summary:
Prop Firms can make money from both traders who fail the selection test, and
from traders who pass it and then actually trade the markets. Whoever invented
the Pro Firms is an absolute genius!
Pros and cons of Prop Trading
Pros
- Access to big capitals: traders will rarely have more than a few thousand they're willing to risk on the market. Instead, Trading Prop Firms can potentially offer traders access to millions.
- Minimal and well-defined risk: since much of the risk lies on the Prop Firm, prop traders only risk their initial investment in taking the challenging program.
- (Big) potential profits: if successful, prop traders can make a significant profit without making much of an upfront investment.
- (Potential) support: some Prop Firms have a good support structure for their traders and provide insights into their profitable strategies.
Cons
- The challenge: the initial challenge could be expensive and difficult to overcome.
- Maintain prop trader status: also maintaining the prop trader status is hard, it becomes a full-time job. You must have discipline and mental fortitude.
- Income is irregular: every professional trader knows that there are good days and bad days. Doing this job you cannot have a predictable monthly salary.
Conclusions
Prop
Trading can offer traders an exciting opportunity, but only professional
traders can hope to pass the selection test and then maintain their status as
prop traders over time.
I prefer to
trade with much smaller capitals (my money!), but free from any constraints on
timing, losses, and gains.
A sincere
wish of good work to all!
Written by F. GRAMOLA (*).
(*) Member of S.I.A.T., the Italian Society of Technical Analysis (member society of I.F.T.A. – International Federation of Technical Analysts).
Warning
We merely cite our personal opinions for educational purposes only.
All trademarks are the property of their respective owners.
Investing
and trading are risky. Don't invest or trade money that you cannot afford to lose.
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