What is Prop-trading in Simple Terms

Prop Trading at Forex

What is prop-trading in simple terms?

To trade forex, you need to find a prop firm’s forex. Prop-trading is an opportunity for traders to trade on the Forex or stock exchange on the company’s funds with the subsequent division of the profit gained. Also US companies, as a rule, require the deposit of a certain amount of the trader’s personal money. 

The definition of “prop-trading” comes from the English Proprietary Trading, which can be translated as “private trading”. Proprietary companies emerged as a result of the association of groups of investors who invested their money in the creation of infrastructure for direct access to exchange trading floors, and the formation of large amounts of capital for trading financial instruments. What is proprietary trading? To trade in the markets such a company attracted private traders providing them with a certain part of the available capital. The trader in turn paid a portion of the profit to the company.

To reduce risks the founder’s investors have distributed funds among a large number of invited traders. For this purpose, they had to develop their own software and hire specially trained risk managers to closely monitor the orders being opened and closed.

Initially, the working scheme of such firms implied that they had to act exclusively on the stock exchange since, unlike the Forex currency market, the stock exchanges did not offer leverage to their traders. The sum given for management became its equal replacement, which attracted traders who had knowledge and experience but did not possess the necessary capital. The result was a mutually beneficial long-term cooperation.

In simple words, prop trading is trading on the stock exchange without the use of own capital.

Where and when did prop trading come into being?

The first prop traders appeared in the US in the early 90s. At that time, the heads of major companies began inviting graduates of well-known financial educational institutions to work. Today in the US there are over 100 successful prop-trading organizations whose employees reportedly make as much as 70% of all deals on Wall Street. Hold Brothers and SMB Capital stand out among the famous companies. This type of business came to the EU territory much later.

Proprietary trading companies in UK began operating with the opening in 2002 of a division of the Canadian Swift. But the peak of interest in proprietary trading came in 2012 with the publication of SMB Capital co-founder Mike Bellafiore’s translation of his book, “One Good Trade: Hidden Information About the Highly Competitive World of Private Trading,” which covers the details of proprietary trading and the very essence of proprietary trading.

The benefits and prospects of a proprietary trader

Proprietary trading is an opportunity for an experienced trader or a beginner with the appropriate talent to learn the skills of professional trading.

How prop trading companies work

The business model of proprietary trading is based on attracting the maximum number of successful traders. Real professionals in this business are in fact very few, so such companies tend to conduct effective training of candidates and arrange regular contests to demonstrate the skills of the participants.

The essence of prop trading The prop firm itself does not provide direct access to the financial markets but uses the services of brokers and dealing centers. As a rule, the partner companies provide prop trading liquidity and all other infrastructure, including online back-office, on more favorable terms than the average client. Therefore, trading conditions for prop traders can differ significantly from those of regular market intermediaries for the better.

Structure of a prop company

Nowadays, proprietary trading companies are often opened by enterprising former traders of similar companies, who have many years of trading experience and accumulated sufficient capital. Usually, they are 1-3 people who are the managing center of the organization, responsible for all major business decisions and major trading operations.

The second link is senior traders. There may be up to 10 of them in the company’s staff. Each of them is in charge of one of the firm’s activities: trading, derivatives markets, securities, scalping, currencies, etc.

The senior traders work directly with the ordinary pro-traders, as with the personally trained, and with the invited professionals. Depending on the size of the company there can be up to 50 or more.

How do I become a prop trader?

To become a prop trader today, you do not need special education or any special knowledge in finance. All one has to do is to provide the prop firm with proof of stable successful trading with real money. This can be done with the help of certified trading reports from any brokerage company.

Many prop firms offer people with no experience to take paid comprehensive training for 4-6 months. However, in this case, you need to know that the educational program passed does not guarantee a position as a prop trader, and the money spent on it, of course, is not refundable.

Another way to get a job as a prop trader is to win the contest on demo or real accounts, organized by proprietary companies.

Getting a job with a big Western organization is much harder. Such organizations usually offer no more than 4-6 positions a year. To get a job as a prop trader you will have to personally go to the office for an interview and convince the management to hire you. However, having great experience in trading in financial markets is not going to be enough: the employer will assess the personal qualities, success-orientation, and even your CV. Preference is given to young people under 30 with no family and other commitments. This is primarily due to the fact that every new trader must go through very intensive training, which can last up to 18 months and will require the full participation of the “newcomer.

Non-market risks of a prop trader

Having figured out what prop trading is, it is also worth taking into account the common opinion that up to 90% of the prop companies in the post-Soviet area are just defrauders. The idea of prop trading in the US, like many Western business models, often takes a perverted form. Thus, the very essence of prop trading is distorted.

The key to the unscrupulous approach to proprietary trading is that the trader contributes his own funds to the account and has proprietary income that does not relate specifically to asset trading. This includes training for money, paid software, trading contests on real accounts, conducting trades within the company without entering the market.

In order not to become a victim of fraudsters, you need to consider a few important points that require special attention.

Deposit amount. A proprietary company requires a trader to deposit a certain amount of money to protect the structure from capital loss and sets the stop-out level equal to this amount. Upon closer examination, the advisability of proprietary trading with this approach raises serious doubts. The deposit supplemented with the company’s money allows increasing the volume of transactions, but it does not increase the room for the current drawdown, which in turn forces this same volume to be limited.

Traders contests. In order to be sure of the future pro trader’s professional qualification, the company offers participation in contests, by the results of which the most prepared traders are selected. Such events can be fully transparent only if they are held on a demo. In the case of competitions on real accounts, there is a risk of non-return of deposited funds to those who are out of prizes. Besides, the victory in a tournament does not necessarily guarantee money management. Also, you need to remember that real trading on financial markets takes place in conditions, which are absolutely different from contests.

Trading platforms. You have to be very careful with the proprietary trading platforms that are offered by proprietary companies. If the program is very uncomfortable, there are constant slippages and requotes, there are non-market price jumps, communication breakdowns, it is very likely that you are dealing with a fraud, which simply will not allow you to trade in profit or withdraw profit.

Tuition-for-pay training. In and of itself, training in a prop firm is mandatory, and a prop trader is actually an employee whose training must be at the employer’s expense. However, many proprietary trading companies in US charge a training fee but do not guarantee employment.

Trading within the algorithm of the company. At first, glance, opening trades strictly according to the proposed rules is very convenient. But when a prop trader invests his own funds, this way he can easily lead to their loss.

Pros and cons of proprietary trading

US with any of the models of interaction between a trader and the financial markets, proprietary trading has its advantages and disadvantages.

The positives include the following:

  • The proprietary trading model provides an opportunity for accelerated development for the private trader. This applies to experience and knowledge as well as capital growth.
  • In the classic variant of proprietary trading (without investing the trader’s own money) there is absolutely no possibility of a conflict of interest between the company and its traders. Such cooperation is beneficial to both parties.
  • Up-trades provide access to the stock market for ordinary traders who do not have significant capital.
  • Working in a proprietary structure promotes discipline and a serious attitude toward risk management as an essential component of trading in financial markets.
  • Distributing a company’s trading capital among a large number of pro-traders is a good way to diversify corporate assets.

Disadvantages of the proprietary business model:

  • The trading algorithms used in trading are primarily focused on making quick profits, so they do not use the principles of long-term investing.
  • Prop companies are not interested in traders who specialize in medium and long-term trading.

The proprietary trading scheme is ineffective in the forex and futures markets, where traders have high leverage and low commissions at their disposal.

Prop trading is first and foremost about working with live people, so the company’s main capital is its traders. Which means it will never require them to deposit their own money to trade. Moreover, traders who show good results can receive special working conditions from the company.

A proprietary firm does not need a trader contest to select candidates. It is sufficient to demonstrate sustained trading within the requirements of the risk managers.

Proprietary traders do not receive a list of instruments for which it is allowed to open orders on a certain day, they are not given commands to enter the trade – everyone applies their own algorithms of analysis and ways of adapting to the current market situation. It is the versatile approach to the market that provides overall stability.

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