What Is Prop Trading?

Classic vs Digital Prop Trading

Prop commerce can be executed through two primary channels: at an in-house trading desk or digitally.

Classic Prop Desk

The traditional route into prop commerce involves applying to a firm to join their trading team. During the interview, one’s trading acumen and experience is examined. If successful, one receives mentorship from seasoned traders and gains access to the firm’s capital for trading purposes.

Starting with a modest budget is the norm until proven trading prowess is demonstrated. Profit realization may span between 6 to 18 months. Notably, demand for these positions is substantial.

Digital Prop Trading

An alternative to the traditional model is online prop commerce. This model eliminates many entry barriers and opens the field to anyone with a passion for trading and a basic understanding of it.

An audition, usually requiring a small fee, is still required by most firms. This process serves to validate your potential as a profitable prop trader, earning you access to a funded account. Occasionally, additional fees such as commissions may be levied by some firms.

Who Is Suited For Prop Trading?

Prop trading can be a fitting pursuit for anyone with trading experience and a discerning understanding of trading practices. Acquiring these skills can stem from diligent practice and meticulous research. A triumphant prop trader needs skill, experience, and a potent trading strategy.

As a retail trader, your route will likely be through online prop commerce. Owing to its accessibility, this method has experienced a surge in popularity. Its less stringent qualification requirements make it a more appealing option compared to traditional prop desk positions, allowing those with less experience or without a finance background to step into the realm of prop commerce.

Presuming your interest in prop trading, it’s likely you’re keen to get started without undue hassle. Therefore, our emphasis is on online prop commerce, given the traditional method’s suitability for those with more experience and a finance background.

Ascendancy of Digital Prop Trading

The dawn of digital prop trading has simplified the process, making it more accessible and a preferred option for retail traders commencing their journey. Despite this, comprehensive knowledge of financial markets and trading is crucial as prop trading, like all types of leveraged trading, carries potential risks.

To initiate trading with a digital prop trading firm, an audition fee is required. This serves as a qualification process, ensuring that the firm’s capital allocated to you for trading is not at risk.

The audition process, while varying across firms, usually mandates an increase in your account balance by 10%, with a maximum loss cap set at 5%. The constant use of a stop-loss order is also typically required. Failure results in forfeiting your audition fee, but reapplication with a new fee for another attempt is an option.

Digital prop firms largely operate in an unregulated environment, hence comprehensive research is crucial due to the myriad of firms available, each offering unique propositions.

Before diving in, it’s essential to understand that while there are considerable advantages, significant risks are also part and parcel of the journey. Being aware of these is crucial prior to embarking on your prop trading journey.

Pros Of Prop Trading

Prop trading bestows a multitude of benefits on firms and traders alike. A salient advantage for traders is the capacity to handle large volumes of financial instruments sans personal financial risk. As a client leveraging the firm’s capital, a significant personal investment isn’t requisite for accessing a funded account.

Clients benefit from direct market engagement, bypassing intermediaries or market makers that some retail traders contend with. This enables prop traders to respond swiftly and effectively to shifting market conditions. Moreover, clients can effectively operate as wholesale traders, facilitating access to enhanced liquidity, amplified leverage, and the scope to diversify portfolios.

Prop trading firms commonly provide access to multiple trading platforms, rebates for augmenting market liquidity, and exceptional customer support.

Most prop trading now occurs online, vastly expanding the potential trader pool.

Pitfalls Of Prop Trading

Despite its numerous boons, prop trading isn’t without risks. Notably, the potential for significant losses looms large. Given that prop traders use the firm’s capital, a trade’s success or failure can materially affect the company’s financial stability.

Additionally, the highly competitive and fast-paced nature of prop trading can make keeping pace with market changes and making informed decisions a daunting task. It typically necessitates an experienced trader with substantial trading acumen to excel as a prop trader.

Many prop trading providers offer an audition process with virtual money before granting access to a live trading account. This trial may entail adherence to risk management parameters such as daily stop-loss usage and not exceeding a specified daily portfolio loss limit.

Tactics For Propriety Trading

Numerous proprietary trading tactics exist that traders can utilize to generate profits.

Prominent strategies encompass short selling, scalping (akin to day trading), and momentum trading. All these tactics are designed to exploit market inefficiencies and capitalise on price discrepancies.

One of the pioneering prop trading tactics is arbitrage, which manifests in various forms, including index arbitrage, volatility arbitrage, and merger arbitrage. Essentially, arbitrage involves capitalizing on price discrepancies across different markets. For example, if an asset’s price varies between two distinct markets, arbitrage entails purchasing at the lower price and selling at the higher price to secure a profit.

However, each tactic carries its unique array of risks and rewards. Consequently, traders should thoughtfully consider their objectives and risk tolerance prior to settling on a strategy.

Embarking on Prop Trading

There are several steps to carving a successful path as a prop trader:

1. Undertake thorough research on financial markets and learn to craft successful prop trading tactics.
2. Hone prop trading skills with virtual currency in a live market setting by opening a demo accounts.

Following this, you have two options:

1. Approach a prop trading firm to join an in-house trading desk utilising the firm’s advanced software and platforms.
2. Opt to become a remote prop trader by applying to an online prop trading firm.

Before approaching a prop trading firm, it’s recommended to start with these steps.

Identifying a Prop Trading Firm

Several renowned prop trading firms, such as Level Up Trading, SurgeTrader, FundedNext, Ment Funding, FTMO, My Forex Funds, and the Lux Trading Firm, cater to traders’ diverse needs. It’s vital to undertake a thorough investigation of each firm’s credibility through online user reviews and testimonials.

For more info, read our full SurgeTrader Review or FTMO Review.

Initiating a Prop Trading Account

After choosing a prop trading firm, account creation is generally simple, albeit procedures may vary among providers.

Account Qualification

Most firms require a test evaluation process to open an account, often involving a one-time fee and an audition using virtual funds in a real-market test account. The goal is to generate typically a 10% profit. Some firms enforce risk management rules to filter for proficient traders.

Trading Instruments

The tradeable financial instruments hinge on the prop trading firm. The range is vast, from forex to CFDs to options, as long as the firm facilitates it.

Sharing Account Profits

Prop trading firms typically offer a profit split of 20% to 50%, some extending up to 90%. Firms only profit when their prop traders succeed, and traders commonly retain most of their earnings, a substantial lure for prop traders.

Why This Type Of Trading Is Growing

Prop trading, tracing its lineage to the 1980s, was a realm initially restricted to resource-rich financial institutions. Banks, traditionally engaged in accepting deposits and lending for profit, started investing these funds in financial markets for client returns.

However, the banking industry’s deregulation in the 1980s and 1990s sparked a transformation. Banks began investing not just for clients, but also with their capital, often through a prop desk.

A prop desk, essentially a trading hub, allows prop traders to speculate on market trends, from shares to real estate to intricate derivatives, operating akin to an in-house hedge fund.

Fast forward to today, technological advancements and financial industry growth have made prop trading increasingly attainable for a wider range of investors and traders.

The Emergence of Proprietary Trading

Proprietary trading experienced a significant surge on Wall Street in the late 1990s and early 2000s. The advent of computers and the progressive sophistication of algorithms facilitated rapid analysis and execution of trades across various financial markets. This development resulted in substantial earnings for banks, with some traders pocketing millions annually.

Driven by these substantial earnings, proprietary trading became an integral aspect of numerous banks’ operational models. Some even established standalone units exclusively for this form of trading. However, these profits were not without substantial risks.

Once you pass the qualification stage, you’ll be equipped with a funded program based on the capital you’ve committed. Accounts can commence with as little as $25,000 in capital and can scale up to a maximum of $4 million, depending on the firm.

Certain prop forex trading firms may also impose ongoing commission fees once you’ve qualified for a live account.

Adjustments in Prop Trading Regulation: The 2008 Financial Meltdown

The financial crisis of 2008 shed light on the risks associated with proprietary trading, underscoring broader issues within the banking industry. Banks actively involved in proprietary trading experienced massive losses, which led to considerable write-downs and eventually to the rescue of several major financial institutions.

In reaction to this crisis, regulatory bodies introduced new regulations intended to minimise the risks associated with proprietary trading. The most significant among these was the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act, incorporating the “Volcker Rule.” This rule curbs banks from engaging in proprietary trading and restricts their capacity to invest in hedge funds and private equity funds.

Present-day Prop Trading Regulations from an Australian Trader’s Viewpoint

In the recent past, proprietary trading has faced heightened examination from regulatory authorities due to apprehensions about financial solidity and potential market manipulation.

Consequently, numerous countries, including Australia, have set limitations on funded trader programs and introduced augmented reporting obligations for firms indulging in this type of trading.

Regardless of these constraints, proprietary trading continues to be a favourable and rewarding pursuit for numerous financial institutions and traders, including those in Australia.

Final Thoughts

In summary, proprietary trading is a financial trading form that utilizes a firm’s capital to trade various financial instruments like stocks, bonds, currencies, commodities, and others. While it does present several advantages such as swift and efficient trading, proprietary trading also carries substantial risks and isn’t typically advised for novices. Before delving into proprietary trading, traders and firms should thoughtfully evaluate their objectives and risk appetite.