Proprietary Trading - What Is
It and How Does It Work?
15 mins read • 23 Jun 2022
Every day, thousands of talented traders around the world enter the realm of proprietary trading. There, they have an opportunity to build a career buying and selling shares, futures, forex, and crypto products.
Read on to learn more about prop trading and how proprietary traders make a good living in the financial markets.
Table of ContentsWhat is Prop Trading?
Proprietary trading is the act of a company (prop firm) hiring third parties (prop traders) to trade their capital. The prop firm allocates risk capital to the prop traders; in return for their services, traders are awarded a profit split.
To determine trader acuity, the proprietary trading firm follows a qualification process. Let's follow the journey of an average retail trader (Trader A) and their transition to becoming a professional prop trader:
- Trader A pays a nominal audition fee.
- Trader A undergoes a "challenge" or "evaluation period."
- Trader A passes the challenge.
- Trader A receives a funded account.
- Trader A is refunded the audition fee and begins trading real money.
- If profitable, Trader A gets a split of any realized gains.
Unlike a hedge fund or investment bank, prop trading is all-inclusive. If you are a talented trader, you can build a career buying and selling financial instruments. Pass the challenge, receive a funded account, and you're in. Simple as that.
Types of Prop Trading
Prop firms come in all shapes and sizes. However, there are three main types of these outlets: traditional prop firms, prop shops, and funded trading accounts. Each is unique and specializes in certain areas of the proprietary trading space.
Traditional Proprietary Trading Firms
Traditional proprietary trading firms are the longest-standing form of prop trading. It is the most restrictive form of proprietary trading and has several rigid components.
First, a traditional global prop trading firm utilizes a mix of trader and firm capital. Second, traders must be certified by local regulators, such as the UK Chartered Institute of Securities and Investments. Lastly, special technology-oriented skills may be required to add value to the firm's market-facing operations.
Prop Shops
A prop shop is a firm where the trader puts up a significant amount of risk capital. Prop shops offer traders market access and additional purchasing power. A positive track record is ideal for candidates, although no formal qualifications are required.
Remote Prop Trading Firms - Funded Trading Accounts
The top proprietary trading firms are found online in the global macro trading environment. Remote prop trading firms offer talented individuals the ability to earn a funded trading account.
No qualifications, experience, or capital are required. Anyone can earn a funded account and trade it remotely from home or office. Many of the best prop trading firms in the world furnish remote traders with funded accounts.
Prop Trading vs. Hedge Funds
Although both prop firms and hedge funds manage large quantities of capital, there are several key differences between the two. Below are three of the largest:
- The capital of prop firms is managed by their traders. Hedge funds staff fund managers to balance the assets of the firm.
- A person doesn't have to be licensed to work as a prop trader; fund managers are subject to regulatory oversight.
- Hedge fund managers are required to adhere to company-approved trading strategies. Prop trading firms allow their traders to engage the market as they deem fit.
Prop trading opens the financial markets to the masses. Regardless of one's background, education, and experience, it's possible to profit from prop trading. In many ways, the prop industry democratizes the global marketplace by funding anyone with the trading skills to consistently profit.
Volcker Rule & Prop Trading
The Volcker Rule states that banks cannot trade securities, derivatives, commodities, futures, and options for their accounts. It defines this act as being proprietary trading. Accordingly, the rule limits interactions between banks and hedge funds, prop firms, and private equity funds.
The Volcker Rule stemmed from the Global Financial Crisis of 2008. Upon the bursting of the subprime mortgage bubble and subsequent credit freeze, steps were taken to limit the trade of securities by banks.
Prop Trading - How To Get a Funded Trading Account and Start Trading
If you're a prop trader, then the proprietary trading firm is your partner in the marketplace. So, it makes sense to focus your business on only the best proprietary trading firms. That's why we believe the ecosystem at HowToTrade is head-and-shoulders above the rest.
At HowToTrade, we furnish aspiring prop traders with the education, market analysis, and support they need to build a career in the markets. Featuring video tutorials, around-the-clock analysis, 24/7 chat, and proprietary trading access, HowToTrade is your all-in-one portal to the marketplace.
Additional Resources On Prop Trading
Looking for more information? Check out these three articles to boost your understanding and scrutinize the prop trading industry in depth.
Prop Trading Firms
Prop Trading Firms [Full Guide]
In this guide, you’ll learn about the different types of firms and the pros/cons of joining each. No matter if you’re a forex, futures, or shares trader, this read is a great place to review alternatives and decide which is ideal for you.
Learn more
How To Become a Prop Trader
How To Become a Prop Trader [A Complete Guide]
Before starting any career, it’s a good idea to know what you are getting into! In this guide on How to Become a Prop Trader, we take a deep dive into all things prop trading. From potential salaries to tips on how to become a pro trader, you’ll have everything you need to begin a career trading prop.
Learn more
Funded Trading Accounts
Funded Trading Accounts [A Guide to Getting Started]
In this guide, we break down the specifications of futures, forex, shares, crypto, and options funded accounts. We also talk about how a funded account works and how to choose the trader program best suited for your needs. If your goal is to get funded, learn more on the link below.
Learn more
FAQs
Below are a few of the most frequently asked questions on proprietary trading. If your question isn't answered here you can read all of our FAQs.
What is a funded trading account?
A funded trading account is a platform that allows participants to trade real money in the live markets. It consists of an allocated amount of risk capital, risk controls, and market access. With a funded account, prop traders can profit from buying and selling everything from forex pairs to the world's major stock market indices.
When traders receive a funded account, they are free to engage the live market as they see fit. As long as risk control parameters aren't violated, the account will remain live. If profitable, the trader will reap the rewards of their hard work.
What is the maximum funded trading account size a trader can get?
Traders are free to shoot for the stars with funded prop trading accounts. Even though many account sizes are designed for smaller traders, advanced alternatives exist. In fact, it's not unheard of for individuals to secure $100K, $500K, $1 million, or $2 million accounts.
In the modern prop environment, it's possible to secure an account upwards of $1 million. This amount of purchasing power is beneficial in many ways. First, it allows for larger position sizes and the generation of extraordinary returns. Second, having adequate equity gives the trader added staying power in the face of market volatility. Third, it furnishes traders with many more scalping, day, and swing trading strategic opportunities.
Of course, larger account sizes typically require enhanced audition fees and sophisticated risk management. Due to these two elements, they are recommended for proven, experienced traders.
How does a prop trading firm work?
A proprietary trading firm funds market-savvy individuals with the purchasing power they need to profit in the live market. To determine the affinity of aspiring traders, prop firms use evaluation periods complete with profit targets and risk controls.
Upon a person satisfying the evaluation framework, the prop firm assigns them a funded account. The prop firm then distributes trader profits according to a predetermined split. In this fashion, firms help solid traders earn a living while boosting their bottom line.
Is there any test to pass before getting a funded trading account?
One of the best things about modern prop trading is that anyone with talent can earn a funded trading account. It's possible in three basic steps: pass the challenge, get funded, and begin trading in the live market. That's it — no advanced degree, coding skills, or experience required.
However, in order to become a funded trader, you must first prove that you have what it takes to be consistently profitable. To do so, you must pass the prop firm's challenge. A challenge typically consists of three elements:
- Profit Target: A defined monetary amount or percentage that needs to be achieved.
- Risk Parameters: Traders must operate within constraints such as maximum drawdown and maximum loss.
- Minimum Trading Days: A set number of days (sessions) that must be traded.
The challenge is your audition to become a funded trader. It aims to determine if you and your strategy can make money while managing risk over time. Although you don't need a Ph.D. to be a prop trader, you must pass a challenge.
What is the initial account size a prop trader can get?
One of the most significant advantages of proprietary trading is the flexibility in the amount of risk capital a trader can qualify for. Amounts range anywhere from $25,000 to upwards of $1,000,000, depending on the firm and financial institutions involved. Generally, greater purchasing power requires enhanced audition fees.
Variable funded account sizes constitute a significant benefit for aspiring prop traders. Traders can grow into their careers at their speed. For beginners, small accounts are ideal due to their limited fees and realistic profitability metrics. However, as the trader grows, many prop trading firms reward success with larger accounts and purchasing power. Many of these advanced accounts are in excess of $1 million.
