Proprietary Trading: All You Need To Know
In prop trading, a proprietary trading firm (or prop desk) gives you its capital to trade across assets like forex, futures, and stocks, allowing you to execute proprietary trading strategies without using your own capital.
Proprietary trading has been booming lately as more and more proprietary trading firms are handing traders the chance to trade with their money, making it appealing to successful traders and those eager to level up their trading game.
But how exactly does prop trading work, why is it such a hot topic, and is there a catch to this seemingly perfect business model? In this article, we're diving into these questions and much more about the world of proprietary trading, so keep reading!
Key Takeaways
- Proprietary trading lets traders access a firm’s capital and share the profits they generate.
- Most modern prop firms require traders to pass an evaluation while following specific profit and risk limits.
What Is Proprietary Trading?
Proprietary trading is when a firm lets other traders use the firm's own money to trade instead of relying on client funds.
Prop traders use the firm's trading capital to buy and sell financial instruments, whether it's stocks, forex, indices, or commodities, and in return, both the prop trading firm and the trader share the profits. The firm takes a slice, and you will receive a nice payout for your efforts.
With some firms like Top One Trader, your payout can be up to 90% and, in some account types, can reach 100%: fast, seamless, and all yours to keep.
The mechanism around prop trading is simple: traders bring their market knowledge and strategies to the table, while the firm provides the cash and often some top-tier trading education.
This setup is a dream come true for traders who can consistently bring results but don't have their own money to play on a bigger scale. For independent proprietary trading firms, it's a good deal, too, they profit without having to execute every trade themselves and it diversifies their risk across many different traders with various trading styles.
Proprietary Trading vs Traditional Trading
In traditional trading, an investment bank, retail traders or other financial institutions act more like middlemen or direct traders. They trade on their own capital or clients' money and usually collect a commission or fee.
Prop trading is different in that the firm's own money is at stake, so proprietary firms are fully invested in the outcome. That's why they're picky about who they bring on board.
- Traditional Trading: Retailers or Financial institutions engage in trades using their own or clients’ capital. When trading with their own capital, traders keep all profits and losses. In contrast, when the institution trades for clients, it usually earns commissions or fees and shares profits or losses with the firm.
- Prop Trading: The firm gives traders its own capital to trade with, and the profits are split between both. This way, both are invested in the outcome. And with more capital available, traders can potentially earn higher profits than they would if self-funded.
Proprietary Trading vs Traditional Trading Table
How Does Prop Trading Work?
Proprietary trading works as a collaborative effort where the firm and the trader bring their strengths to the table. Here's what the process looks like:
1. Qualification Process
First, before traders can handle real money, they usually have to pass a qualification process. This usually involves:
- Signing up for an evaluation phase/challenge account: Select from 1-step, 2-step, 3-step, or instant funding options and pay the fee. Many prop trading firms also offer a demo account where they can show their skills.
- Meeting performance targets: Traders must hit certain profit targets while managing risk.
Passing evaluations means traders must hit a profit target of 8% to 10% (varies by firm) in Phase 1 and 5% in Phase 2 for a standard two-step challenge. While chasing these gains, they must strictly manage risk by never breaching a maximum daily loss limit of 5% or an overall account drawdown of 10%.
- Getting access to capital: Once the trader passes the evaluation, they start trading with the firm's funded capital.
It might seem daunting, but this process ensures that firms are working with traders who know how to handle the market and manage risk properly.
2. Capital Allocation
When a trader joins a prop firm, they're handed access to the firm's money: this is the capital they'll use to trade.
The amount of capital depends on which size trading account the trader chooses in the evaluation/challenge stage. Many prop trading firms offer account sizes ranging from $5,000 to substantial capital upto $200,000. Prop firms charge a fee, based on the size of the account, in order for the trader to take the challenge.
3. Trading Strategies
Once a trader gets the green light with capital, they use different strategies to work the market. These can be:
- Scalping: A fast-paced trading style where proprietary traders aim to profit from small price change market opportunities by making numerous trades within short timeframes, typically under one hour.
- Intra-Day Trading: A style of trading where the trading activities (buy and sell) are opened and closed within the same day. Traders aim to capitalize on short-term price movements and avoid holding positions overnight.
- Swing Trading: A medium-term trading style where traders hold positions for several days to weeks, aiming to profit from price swings or "swings" in the market.
- Trend Trading: A strategy where traders aim to capture profits by identifying and following the prevailing market trend, holding positions for as long as the trend remains intact.
- Range Trading: Traders identify support and resistance levels and aim to profit from price oscillations within a defined range. They buy at support and sell at resistance, avoiding trending financial markets.
Asset Classes Traded: Prop traders operate across multiple financial markets, including foreign exchange (forex), stock futures, options, and commodities.
Automated & Algo Trading: Many traders utilize custom EAs (Expert Advisors) and algorithmic models to execute quantitative strategies while maintaining strict risk management parameter controls.
Traders can choose their own strategy, but the goal is always the same: consistent profits.
It's important to note that almost all legitimate prop firms strictly forbid what are known as toxic and/or high-risk trading strategies, such as:
- Hedging: Executing trades for both long and short positions on the same currency pair, often within the same account, to offset risk. Some firms prohibit this because it can distort risk management and P&L reporting.
- News or global macro Trading: Entering trades just before or during major economic news releases (e. g., NFP, interest rate decisions). Firms may ban news trading to avoid the high volatility, slippage, and unpredictable price spikes that can occur.
- Martingale Strategy: A risky strategy where traders double their position size after each losing trade, hoping for a single win to recover losses. This can lead to significant drawdowns and is often restricted due to the high risk of blowing up the account.
- Latency Arbitrage: Exploiting delays between different brokers or trading platforms to take advantage of price discrepancies. Prop firms ban this strategy because it's seen as exploiting technical inefficiencies rather than true market dynamics.
- Grid Trading: Placing multiple buy and sell orders at regular intervals both above and below a current price, often without stop losses. This strategy can lead to uncontrolled losses in trending markets, so it's often not allowed.
- High-Frequency Trading (HFT): Extremely rapid trading, usually done using algorithmic trading or automated systems, aimed at profiting from minute price changes.
- Copy Trading: Relying on mirroring trades from other traders or third-party signals or EAs instead of executing original trades. Prop firms usually expect traders to demonstrate independent decision-making and consistent performance.
4. Profit sharing
When the traders make money, the profits are split between them and the firm. The split varies, but it typically looks something like this:
As traders prove their skills, they might get better profit shares, but the split always works so that both sides benefit from successful trades.
Types of Prop Firms
There are generally two main types of prop firms, each with varying levels of independence, structure, and support, so let's break them down:
Traditional Proprietary Trading Firms
Traditional prop trading desks allow traders to trade the firm's capital. In traditional firms, the firm keeps most of the profits, giving the trader a small share. Trading with a traditional prop firm typically requires a college degree, and traders go through a rigorous, highly competitive interview process.
Competition is fierce, and only top-qualified traders make it here. Traders are typically expected to trade in the firm's office and, as a benefit, receive comprehensive training and support.
Modern Proprietary Trading Firms
Modern prop trading firms also allow traders to trade the firm's capital; however, the trader keeps the majority of the profits. Modern prop firms offer more flexibility, giving traders control over their strategies and capital.
Since there is no requirement to be in a physical office, traders can live anywhere in the world. Another benefit of modern prop firms is that instead of going through a rigorous interview process, any trader may qualify as long as they pass a paid evaluation/challenge.
Institutional Prop Desks vs. Online Evaluation Firms
Investment Banks & Hedge Funds: Major institutions like Goldman Sachs or Jane Street operate proprietary desks primarily focusing on market making, quantitative trading, and algorithmic trading.
Regulatory Compliance: Under regulations like the Volcker Rule, bank-affiliated proprietary trading desks face strict restrictions compared to independent online prop firms.
Prop Trading Pros and Cons
Like any career, prop trading has plenty of upsides, but it also has downsides. So, let's talk about the pros and cons of being a prop trader.
Pros:
- Access to Capital: One of the biggest advantages is that you're trading with the firm's money, not your own account. This lets you scale up your trades for larger returns, all without needing a huge personal bankroll.
- Lower Risk: Since you're not using your own money, you avoid personal financial risk. However, the firm's capital is still on the line, so doing well with it plays a huge role.
- Profit Potential: When the firm's capital is backing you, your profit ceiling rises exponentially. If you consistently perform well, you can see amazing returns.
- Support: A good prop firm won't just hand you cash and leave you in the dust. It'll give you access to top-tier trading tools, data, and mentorship to keep you sharp and competitive.
Cons:
- Lack of Structure: While the freedom to trade independently is great in modern firms, this also means there's less guidance. Without a set structure, you must rely entirely on your own strategies and discipline, which can be hard unless the training is top-notch.
- Risk: While it's not your money on the line if you underperform, you risk losing your account should you exceed the firm's maximum loss on the account. It's important for traders to follow solid risk management. While there is no capital risk on the account, the trader's risk is the expense of the evaluation/challenge fee should you not pass your evaluation.
In the end, being able to trade prop firm capital offers the most realistic opportunity to become a full-time trader. It's a thrilling gig if you have the skill and the nerves, but it's definitely not for everyone.
How To Become a Prop Trader
As we've discussed, becoming a prop trader isn't as simple as signing up and starting to trade with someone else's money. Most prop firms need to know that you have the skills and mindset to make it work, and that's where the vetting process comes in.
Qualification Process
It typically starts with an evaluation period, during which you'll trade on simulated accounts so the firm can assess your skills without risking real money. Top One Traders offers a simple approach, with either a one-step, two-step challenge or instant funding.
Steps to Becoming a Prop Trader:
- Research Prop Firms: Look for reputable firms with fair profit splits and upfront conditions.
- Enter Evaluation Program: Participate in demo trading and meet the firm's performance expectations.
- Pass Performance Milestones: Hit profit targets while staying within risk limits.
- Secure Funding: Finally, get access to the firm's funded capital.
Skills Needed
As a prop trader, you need solid technical skills like financial analysis and risk management to make good trading decisions.
But that's just the start. You'll also need qualities like stress tolerance, quick decision-making, and a calm mindset when the market goes wild. Prop trading can move fast and get intense, so being able to think on your feet is how you stay in the game.
Final Thoughts
Proprietary trading can be a great way to use someone else's capital to sharpen your trading skills and make money while doing it. But it's not always easy, you need to manage risks, hit profit targets, and handle the ups and downs of the market.
The trick is to find a good firm and make sure you have what it takes. So, if you're up for a challenge, take the leap with Top One Trader and dive into the world of prop trading! Who knows? You might find it's exactly what you're made for!
FAQs
Is proprietary trading legal?
Yes, proprietary trading is legal, but the rules and regulatory requirements vary by country and how the firm operates.
Do prop traders use real money?
It depends on the firm and program, as some use simulated accounts while others provide access to live market capital.
How much money can a proprietary trader make?
A trader’s earnings depend on their profits, account size, profit split, and the rules of the proprietary trading firm.
Do you need a license to become a prop trader?
Generally, traders using a firm’s capital under its trading program do not need an individual trading license.
What happens if a prop trader loses money?
If losses breach the firm’s risk limits, the trader can lose access to the account and may need to pay for another evaluation.
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