What Is Proprietary Trading?
Proprietary trading is done by a financial firm (bank, privately held company, etc.) with the aim of making profits trading the stock market, forex, futures contracts (derivatives), crypto, or options contracts. Typically, mathematicians, experts, and algo trading dominate this sector. Yet, prop firms are continuously looking for new talents who can handle the emotional stress related to trading when it comes to manual trade executions besides the regular automated trading approach.
How Does Proprietary Trading Work?
Proprietary trading is an advanced trading approach and is typically handled by companies with immense IT resources. A prop firm mainly hires trading system developers and coders to let the coded trading systems run automatically. A form of prop trading can be HFT trading, but trading on larger time frames is also typical for prop trading in a classical sense.
A prop firm provides the capital, which gets traded by the so-called prop trader within the prop shop. This person gets paid based on success and seldom with a fixed salary. The main benefit of this type of prop trading in-house in a big city with near-location offices close to the exchanges is that the earnings potential is unlimited. The better you trade, the more money you make. Since the prop firm heavily invests in education, the profit split, or profit share, is typically capped at 50%. So, the traders can keep up to 50% of the profits made for the prop firm.
Prop Trading Today
Prop trading today significantly differs compared to what it was a couple of years ago. These days, prop firms, also called prop trading firms or proprietary trading firms, hire traders worldwide from all over the world for remote-based trading instead of requiring them to work locally in New York City or Chicago.
While it was not untypical that a prop trader who was working for a local proprietary trading company had to bring some risk capital, today, a prop trader can avoid bringing in any capital to get funded.
Instead, it works differently. While in the past, there were interviews between the prop firm and the potential prop trader to evaluate if the person gets hired, these days, even traders who need to gain education can begin a prop trader career.
All needed is setting up a prop trading account with the desired prop firm, trading by the rules, and reaching the profit target in order to get funded.
What Is a Prop Trading Challenge?
A prop trading challenge is a contest where you prove that you have the skills needed to trade the prop firm’s money successfully. Instead of going through an interview, you directly start trading in a virtual environment. If you reach the profit target (e.g., 8% of the initial buying power), you get funded by the prop firm, and from there on, you can receive up to 100% of the profits made in your bank account.
There are three different types of prop trading challenges:
- Instant Funding: Instant funding sounds the best, but it’s not. Instant funding means that you trade live from day one with the ability to withdraw profits. However, there are two significant disadvantages with instant funding challenges. First, the buying power of the account is typically extremely low, like $5,000. Second, if you start right away with a funded account and without ever having practiced the trading platform or trading methodologies, it’s highly likely that you fail.
- 1-Step Challenge: The 1-step challenge is the most popular prop firm challenge type. Here, you start by trading paper money in a virtual account, aiming to reach the profit target (typically around 8%-10% of the initial buying power amount). Once you reach the profit target, you get funded and then can withdraw the money based on the profit split. If the profit split is 90/10, you can withdraw 90% of the profits you make in the funded account.
- 2-Step Challenge: The 2-step challenge is where most of today’s prop firms started their business models. Here, you have to win once in a paper trading account, reach the profit target, and then once again successfully complete a second challenge successfully before getting funded in a third step. The main benefit of the 2-step challenge is that it’s typically cheap to participate. However, the likelihood of success going successfully through both steps is statistically lower than in the 1-step challenge.
Do Prop Traders Make Good Money?
About 90% of prop traders fail. That’s an unsatisfactory fact. However, prop trading can be immensely profitable when approached correctly. Consider that you are paying $100 to participate in a prop challenge. You grow the account to $1,000. Now, you can withdraw the entire money and start 9 new challenges for $1,000 simultaneously. If you grow those accounts, your profits multiply.
The secret weapon to successful prop trading is that you withdraw the profits before they melt away. Most traders fail because, at some point, they become greedy or make wrong decisions. And that’s especially true if there are reasonable profits in an account. The behavior here is often, hey, those profits are great, and if I made 1,000% in profits, I could make 10,000%. And that’s where the downward spiral typically begins. That’s why it is key to withdraw profits to the bank account soon and start over with new challenges. If you are good, you will easily grow multiple accounts and bank frequently.
Think of it like having a business case for a business. You can grow it and sell it for a 40 multiple. Then you start over again. If you are good, you can make prop trading profitable fast. And by the way, another benefit of withdrawing profits early is that you can quickly see if you selected an excellent prop firm that really withdraws the money to your bank account.
