Proprietary trading refers to financial companies that use their capital to speculate on financial markets and make money. These companies often hire traders by conducting various trading challenges and evaluation programs to select the best-performing traders. Proprietary trading firms will then allow traders who pass the challenge to trade on a funded account. Prop trading firms offer traders unique opportunities to trade on large accounts with substantial trading capital, sometimes even several millions of dollars. If you are a trader who is performing well on financial markets, prop trading might be the style of trading to make a living without using your capital.
Understanding the Basics of Proprietary Trading
Not everyone has tens of thousands of dollars to start trading on financial markets and make a living. This is where prop firms come into an equation. They offer the opportunity to use a funded account and will take a small portion of profits in return. This portion is called profit share, and reputable prop firms will give 80% and a higher percentage of profits to traders. Here is how prop trading works:
- Trader signs up for a challenge or evaluation phase with the prop firm.
- Prop firm will provide login details for its partner broker where the trader has to trade on the demo account and hit a predetermined profit target.
- During the evaluation phase, traders have to operate within strict risk parameters including but not limited to daily loss limits, absolute drawdown limits, News trading restrictions, trading style restrictions, and so on.
Proprietary trading firms impose these restrictions to safeguard their funds and to ensure that only traders who demonstrate robust risk management abilities are successful. As you would already deduct, trading on the funded account is not an easy task and requires even closer risk management than live trading with your funds. There are certain limits on trading styles as well, as prop trading restricts traders from using risky strategies that can lose more than 5% daily. Trend-following strategies will be difficult to implement for the prop trading challenge, as they are known for lower win rates. We will discuss the best prop trade strategies later in more detail.
The core of prop trading is to aim for higher profits, as the trading capital is higher than what a regular trader can deposit. Some prop firms offer 100k and above funding for traders with sometimes high leverages of 1:100 meaning the trader can make much higher profits than they would with a small account.
Some prop firms have their personnel consisting of pro traders who trade on behalf of the firm and take salaries and bonuses. Proprietary trading firms often have dedicated teams or divisions whose primary objective is to make direct market bets. These teams use various trading strategies including short-term trading, algorithmic trading, arbitrage, and derivative strategies. These firms get their gains from trading activities rather than through commissions from clients. However, the vast majority of prop firms allow traders to take an evaluation challenge and will require a small fee.
How Proprietary Trading Differs from Other Types of Trading
Prop trading is slightly different from traditional live account trading, as it requires traders to use superior risk management tactics. Traders have to adjust their strategies to align with the rules and limitations imposed by the prop firm.
Prop trading is different from traditional client-driven trading, where brokers buy and sell securities on behalf of their clients. In client-driven trading, the main goal is to service the investment needs of the client, and profit is generated primarily through commissions and fees.
Prop trading is focused solely on generating profits from direct market activities.
Another critical difference lies in the source of risk. In proprietary trading, the firm assumes the full risk of its trading activities. This differs from brokerage and other client-focused trading operations, where the clients primarily assume the risk. Prop trading also often involves more aggressive trading strategies, such as high-frequency trading and complex derivative positions, which are not commonly used in typical client-focused trading. The majority of prop firms allow traders to sign up and show their trading abilities. When a trader has a positive performance, the prop firm will then give the trader a funded account to speculate on financial markets. While brokers act as middlemen and allow traders to buy and sell securities, prop firms give traders the trading capital to initiate trading positions. Prop traders have partner brokers through which traders can engage in financial trading on the funded accounts.
Who are prop traders?
Prop traders are skilled traders who specialize in making high-stakes decisions with the firm’s capital, hence the strict rules and limitations. Prop traders should research market trends, analyze financial data, develop trading strategies, and execute trading positions. Apart from making informed decisions, prop traders must be adept at managing risk and protecting the firm’s capital.
To become a successful prop trader, there are several steps to follow. The most obvious one is to develop a trading strategy that has a relatively high win rate and strong risk control tactics. Selecting a reliable prop firm is also a must, as many scam firms are just collecting funded challenge fees and do not allow profit withdrawals. Let’s define the necessary steps for becoming a successful prop trader.
How to become a successful prop trader — From Zero to Hero
Becoming a prop trader can be super attractive because of how large the funded account can be. Being able to pay a small audition fee for a 100,000 USD trading account can offer the unique possibility of making a living in trading. However, there are specific steps to follow.
Step 1 — Education and Specialization
Without understanding the basics of financial markets, trading instruments, and economic indicators, making profits is not possible. Fundamentals of financial trading are a must. When learning about financial markets, try to choose one specific market and instrument or instrument and specialize in it, such as Forex, futures, etc.
Step 2 — Developing trading skills
To develop the necessary skills, it is important to practice without financial risk and familiarize yourself with the trading platform. You need to know how to open and close trading positions, set stop loss and take profit orders, and other significant features of trading. Learn how to apply indicators and drawing tools to the charts. Chart types are also significant to master.
Learn technical analysis by analyzing market charts, trends, and patterns. This is critical to select one favorite method of analysis and master it to its fullest. Some traders love candle and chart patterns, while others use a combination of indicators and levels. Learn about support and resistance levels to see where price might struggle.
Step 3 — Gain experience
Start trading on a demo account and test different strategies, this will help you gain experience in trading in general. Maintain a trading journal to keep track of your trading activities. This is especially critical for trading strategy testing and development. Stay updated with market news, trends, and learn from successful traders.
Connect with other traders and seek guidance from experienced traders. Forums, social media, and trading communities will help you learn more about trading. Attend trading workshops and participate in trading competitions to deepen your knowledge of practical trading.
Step 4 — Understanding Prop trading firms
Identify the reliable pop firms that offer trading challenges. Understand their models and learn about different funding models and what they require. You must know what their profit split, drawdown rules, and other limitations are.
Step 5 — Prepare for the funding challenge
This step is the most important. Understand the specific rules and objectives of the funding challenge including profit targets, daily loss limits, maximum drawdown, allowed trading strategies, and allowed trading hours.
You can simulate trading challenge conditions by trading on the demo and following all the rules set by the firm. This way, after 25-30 demo trades, you will have sufficient data to check if the strategy can hit profit targets within a reasonable period and if it follows the risk rules of the firm. You have a clear understanding of whether you can pass the challenge with your trading strategy or not by analyzing its win rate, risk-reward ratio, and drawdown levels.
Step 6 — Passing the funding challenge
Sign up for the challenge and apply your trading strategy consistently. Do not deviate from your trading strategy rules, even if there are no setups and trading becomes boring. Adhere to the risk management and all the other rules to ensure you are not getting disqualified. You can adjust your strategy slightly to adapt to changing market conditions, but it is not recommended during the evaluation phase.
Step 7 — Trading on a funded account
Trading on a funded account is even less emotionally stressful, as you can now start earning profits and making withdrawals. Follow the rules strictly and ensure your drawdown levels are below the requirements. You could also reduce the risks to ensure long-term funded trading performance.
