No. There are some bad actors in the industry to avoid, and becoming a profitable prop trader can be very difficult, but prop trading is not a scam. There are great prop firms out there that can fund your trading strategy and help you maximize your profits.
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Why do people think prop trading is a scam?
Most prop trading firms are perfectly legitimate, but the industry suffers from a persistent reputation problem. Why is that?
Prop trading sounds too good to be true
A lot of people doubt the validity of prop trading companies just because it sounds too good to be true.
Do you mean to tell me that you will give me money to invest and if I lose it, I don’t owe you anything? All I have to do is give you a couple hundred dollars now and I’ll get $10,000 to invest?
That sounds like an email offer from a far-off prince who just needs your help to get access to his inherited millions. It’s not.
That is really how prop trading works.
The prop trading firm gives you money. If you profit, you keep a big percentage, if you don’t they cover your losses. Really.
Of course, it is not quite that simple. You can’t just take the $10K, throw it all into one risky investment and hope for the best, knowing that they’ll cover you if you’re wrong.
Prop trading firms have strict trading parameters, especially when you are just getting started, that limit the amount of risk you can take on.
Different prop trading firms use different methods, but all of them use tools to prevent risky trading behavior and large losses. They employ some combination of stop loss order requirements, draw-down limits, daily loss limits, overall loss limits, limits on overnight positions, limits on whether or not you can trade news releases, and other methods to keep traders within an acceptable level of risk.
Yes, prop firms will give you their money to invest, but they do so in such a way that their capital is well protected.
History of the term “prop trading”
Proprietary trading got a lot of negative publicity as a result of the 2008 financial crisis. Prop traders at the big banks were responsible for billions of dollars of losses, the bankruptcy of some of Wall Street’s most venerable banks, and nearly the downfall of the entire financial system. Not good!
As a result, the Volcker Rule was passed, which prohibited banks from engaging in proprietary trading.
Prop trading is definitely not illegal, but thanks to the Volcker Rule, a number of people have the misconception that it is. It’s only against the law if you are doing so on behalf of a big bank.
Prop trading is legally thriving at independent prop firms worldwide.
Some of these prop firms are still very much a part of the old guard and employ professional traders typically from Ivy League Schools. Other prop firms invite independent traders from anywhere in the world to pay a fee and/or pass an evaluation to receive a funded account. Traders with a funded account can trade the firm’s capital within certain parameters.
This new type of prop trading, which is accessible to just about everyone with an internet connection, is about as far removed from Wall Street’s version of prop trading as you can get (for better or worse.)
It’s hard to become a profitable prop trader
The degree of difficulty involved in becoming a successful prop trader leads to a lot of disparagement towards the business.
For every success story you see splashed across a prop firm’s website, there’s many other traders that don’t make it, and many of them blame their prop firm rather than their trading strategy.
Trading parameters are part of what makes it difficult to make money with your prop trading account. When risks are limited, so too are rewards. And, in a lot of cases, if you violate the trading parameters, your account is automatically terminated and you lose your sign-up fee.
Since they are providing the capital, prop firms are not looking for the traders who take on heavy risk and occasionally walk away as big winners. They are looking for consistently profitable traders who have a disciplined strategy and can achieve returns in the 10% range without taking on substantial risk.
Even for a seasoned, professional trader that’s not easy!
Firms that have evaluation periods or give you a demo account will not let you move on to a regular, funded account until you prove that you can make money despite these limitations. Firms without evaluation periods also keep you on a similarly tight leash.
With most prop trading firms, the parameters ease a bit as you pass evaluation phases and continually prove yourself to be a responsible trader. You are permitted to take on more risk, you might be granted more leverage and some firms open up a wider range of securities you can trade.
The problem is that many if not most traders never make it to this point.
While the prop trading firms are just trying to protect their capital, some traders find the parameters so restrictive that it’s impossible to make a profit. To them, prop trading seems like a rigged game.
Just about every legit prop firm, no matter how respected they are, has some bad reviews along the lines of “It’s just a scam!”
Many of these reviews come from disgruntled traders who didn’t understand the trading parameters before they joined. It’s really easy to fail when you don’t bother to learn the rules.
That’s not to say all negative reviews should be ignored. When reading reviews, it’s important to look for professional reviews, or to try to differentiate which reviewers are just bitter from those who have legitimate concerns.
Bad actors in the industry
The prop trading business is not well regulated, and as a result there are some prop firms that definitely don’t have the traders’ best interests in mind. These prop firms aim to profit off the one-time initiation fees or monthly fees rather than off a percentage of a successful trader’s profits.
True, just about all prop firms make money off failed evaluations, but some look first to fail their traders rather than instruct and support.
Perhaps the simplest way to tell the difference is to see how much a prop firm invests in trader education and customer support. A good prop firm wants its traders to grow and learn and makes significant investments in educational resources. Some of the best prop firms even hire psychologists to help with the mental aspect of trading. They’re willing to do anything to help their traders become profitable traders.
Bad prop firms don’t make large-scale educational investments because they truly don’t care if their traders succeed. They’d prefer you fail, sign up, pay your fees again, and fail again.
Also pay attention to your prop firm’s customer service department. Everyone knows how quickly the markets move. Whether it’s forex trading or equities, things change in a nanosecond. If you’re having issues executing a trade, you’re locked out of your trading account, or if you’ve made a trade in error, you need customer support to respond immediately. Not in 4–5 hours, not the next day.
A prop firm that doesn’t care about your long-term success doesn’t invest in sufficient, well-trained customer support. If they want you to fail, why would they pay someone to help you succeed?
Bad prop firms also don’t provide clear trading parameters, or make them so restrictive that profits are nearly impossible. Make certain you understand your firm’s drawdown limit, the number of trades they allow per day, the initial account size you’ll receive and all the other trading requirements. Then decide whether or not you can succeed within these limitations.
How to have a good prop trading experience
For starters, you have to be realistic about your odds of success. If you’re going to be making money as a prop trader, you have to be very disciplined, very risk-conscious, very attentive to detail, and very market savvy. Does that sound like you?
If not, maybe you should further your education before going the prop trading route, or you should seek a prop firm that puts a high premium on education and is willing to help guide beginners.
It is also absolutely imperative that you understand the trading parameters of your prop firm. The easiest way to have a bad prop trading firm experience is to violate the rules within your first few days and watch your account automatically close. You’ll lose your initial fee and won’t gain any useful trading experience. Know the rules, before you begin.
It should go without saying, but you also need a mastery of the market you’ll be trading in. Most prop firms only offer forex trading, so you should have some level of forex expertise.
Have a strategy before you sign up for a prop trading account. Once you sign up for a prop firm, most of them have you on some sort of clock. You may have only 30 days to meet profit objectives. This is not the time to be experimenting with different strategies. Have a trading strategy that you can begin to execute as soon as your trading account becomes active.
Read reviews. Start with my best prop trading firms article! Some prop firms are better than others, and some prop trading firms are better for you. There’s a lot of reviews out there, both from experts and from actual users, so take advantage of this free information and know exactly what you are getting into.
Understand the risks that are involved. The markets are inherently risky. One of the great advantages of using prop firms is that you transfer some of that risk onto the firm, but remember that your own money and time is still at stake.
Whether you opt for a prop firm that charges monthly fees or a one-time fee, make sure that you can afford to lose the fee(s) should your trading strategy not pan out.
Bottom line: Is prop trading legit?
Yes. Prop trading is legit. A good trader can pass an evaluation, pay a one-time fee, get a funded account, and have access to a prop firm’s capital. If they continue to trade profitably, they’ll get more capital to trade (up to $2 million in many cases) and keep a significant portion of the profits they earn.
That, of course, is the best case scenario.
The worst case scenario is a trader who signs up with a prop firm that offers few resources or trader support and enforces very strict trading parameters. The trader has to pay money, of course, to cover the one-time fee but has a hard time with the trading rules and doesn’t know where to turn for help. Within days they’ve violated the rules, have lost their fee, and are given the choice between giving up or paying more money to reopen their account.
You can make money as a prop trader, but it’s difficult, so make sure you give yourself the best chance to succeed:
- Only sign up with a trusted prop firm.
- Understand the trading parameters and how to manage risk.
- Have a sound trading strategy before you begin.
- Intimately know the market you’ll be trading in.
Follow those steps and time the market right, and you’ll be happy you fell for the “scam” that is proprietary trading.