page title icon What is prop trading?

Financial markets are more accessible today than they’ve ever been. People from all walks of life are trading stocks, bonds, forex, commodity futures, derivatives, and any other financial instrument you can think of. 

Good traders are supplementing their incomes and adding to their retirement funds. Great traders are getting filthy rich. 

But before they started having wine and cheese parties on their yacht, they all started with one thing — at least a little bit of cheddar. That’s right. Capital. Cash. 

That’s the rub. You need money to make money.

An increasingly common way to work around a lack of starting capital is to join a proprietary (prop) trading firm. A good prop trading company can help get you started with a little seed money and a lot of guidance. 

Prop trading is definitely not for everybody, so read the following carefully to see if it presents a good opportunity for you. 

Prop Trading: A Traditional Definition

By the simplest definition, proprietary trading occurs any time a firm uses its own money to trade any sort of financial instruments in order to bolster company profits, but when people talk about proprietary trading today, they are often talking about something very different from when they used the term in the past. 

Prop Trading: A Modern Interpretation

While the meaning of proprietary trading has remained consistent — prop trading is still a firm trying to profit by investing its own capital — the people and institutions that participate in proprietary trading have changed dramatically over the past few years.

In the not-so-distant past, when people talked about proprietary trading, it was almost always with regard to proprietary trading desks at investment banks. Traders on the “prop desk” would buy and sell securities using the bank’s money in the hope of driving up the bank’s profits and earning themselves hefty bonuses in the process.

These trading desks were called proprietary desks to keep them separate from the other traders at the bank who were making trades on behalf of their brokerage clients.

Everything changed due to regulations passed in response to the financial crisis of 2008. The death of major banks like Lehman Brothers and Bear Stearns and the near-total collapse of the international banking system brought a lot of scrutiny to the big banks. 

The prop desks were an easy target for regulators. When they made massive profits, that money was split up amongst the traders themselves, bank management, and shareholders. When they suffered large losses, however, the entire economy was in harm’s way. 

Lawmakers approved the Volcker Rule in 2010 and began to implement it in 2015. The law essentially took commercial banks and investment banks completely out of the proprietary trading game.

Proprietary trading didn’t die, however, it just moved to different financial institutions. Although some hedge funds and other asset management companies still engage in proprietary trading, the term, as most commonly used today, refers to these smaller, independent prop trading firms or “prop shops”. 

These specialized prop trading firms have a large amount of capital that they entrust to traders. The firms split any profits with the trader according to a predetermined percentage and cover any losses up to a predetermined limit.

This is where you, the individual trader, come in. 

There are many different types of prop shops, but some allow individuals such as yourself to join their firm provided that you pass a test and/or pay certain fees in order to participate. That means if you clear the right hurdles you too could have access to a prop firm’s capital.   

The days when proprietary traders only worked at a trading desk in an investment bank and had college degrees in corporate finance or applied mathematics are over. Now proprietary traders can come from different walks of life and can trade from the comfort of their own homes.

So these days, when someone talks about proprietary trading, think Main Street as well as Wall Street.

Different types of proprietary trading companies

Prop trading firms run the gamut from the impossible to join (they’ll find you — probably as you graduate from Harvard as a 12-year-old genius) to companies that will accept anyone as long as their monthly fees are paid on time.

Yes, that’s right, some firms will basically charge you a fee to work for them. Essentially, you’re renting capital from them, or essentially paying steep interest on the capital that they’re letting you invest. 

You have to be very cautious with firms of this ilk. Many firms like this profit as much or more from people who continue to fail (as long as they continue paying their monthly fees) than they do from splitting profits. Their business is based on recruiting as many new traders as they can and then collecting a monthly fee from those traders for as long as they can. In other words, they have no incentive to help guide you to success.

Can you make money with this type of prop firm? Yes. But your strategy better be airtight because you have to overcome exorbitant monthly fees before you even begin to make a profit.

Between these two extremes — the prop firms that only recruit teenage Ivy League valedictorians and the firms that want to take advantage of your optimism and bleed you dry with monthly fees — there is a sweet spot of prop firms. These firms will “hire” you regardless of your background, but also provide the opportunities and guidance you need to help you reach your goals.

Maybe you’re seven years old and already a high school graduate. If this is the case, you’ll probably be fielding calls from the most distinguished prop shops in the world. They will hire you and offer a job with benefits and extensive trading. 

But, if you’re not a math prodigy, you can still find a prop trading company that will take you on as an independent trader and literally invest in your success.

Advantages of proprietary trading

Why split profits with a prop trading firm when you could just keep all of your profits for yourself? Why jump through a bunch of hoops to pass a trading evaluation when your strategy is already a proven winner?

Although it’s definitely not for everyone, being part of a proprietary trading company has some very distinct advantages. 

Capital

The biggest advantage of proprietary trading is that you will suddenly have access to capital. You are no longer limited to trading your own money. 

Bear in mind that as a new trader you may be asked to start with $10,000 or less but, as your trading strategy bears fruit, you will often be entrusted with even more of the firm’s capital.

Training

This is the factor that often separates good prop trading firms from the bottom feeders who are just after your monthly fees. 

Good proprietary trading firms want you to succeed; in fact, they depend on your success to improve their own bottom line. It makes sense then that they would invest in your education and ongoing guidance. 

Really good prop shops will provide advice from seasoned traders and make sure there is always someone around to quickly answer your questions.

If you are interested in prop trading because you already have your own trading strategy in mind and don’t think you need any further training, you should still look into a firm’s educational resources for two reasons. First, because the number of financial instruments are nearly endless and you can always learn something new, and second, because there is a direct correlation between how legitimate a proprietary trading firm is and how much they invest in the ongoing education of their traders.

Don’t join a proprietary trading desk that doesn’t offer training and support. If they won’t invest in you, don’t invest in them.

Limited losses

Another distinct advantage of trading someone else’s money is that you’ve got no skin in the game in terms of your own capital. Of course, the downside to that arrangement is if you lose someone else’s money, they won’t give you access to it for very long. 

So while you might not have your own money on the line, you are still risking your long-term relationship with your firm, and your trading strategies that have led to more losses than gains will rapidly leave you looking for new work.

Resources

Really good prop shops have access to sophisticated software, information, and trading platforms that you probably could not access on your own. 

Before you join a proprietary trading company, make sure you know what information and tools they will be giving you to succeed. Like with training and education, what type of resources a prop shop provides you with is a good indicator of how invested they are in your success.

Disadvantages of proprietary trading

As I said before, proprietary trading is definitely not for everyone. The biggest drawback being that with many prop trading firms you won’t be an employee which means no benefits and no salary. You’ll make as much as you earn through your trading and not a penny more.

To the super confident amongst you, this probably doesn’t seem like a problem; you believe in your trading strategy and are comfortable. 

But even the most experienced traders will make bad trades, the economy is still cyclical and markets never cease to surprise. The question then is, without salary or benefits, how do you cope with the downtimes? Can you put aside enough during the booms to deal with the busts?

For many prop traders, there’s simply no safety net.

There’s also the question of job security. Prop trading doesn’t offer a whole lot of that either. Lose enough money and you’re out. It doesn’t matter how personable you are or how well-intentioned. It doesn’t matter if you just suffered an inconceivable streak of bad luck. It doesn’t matter if your boss’s beagle attended the same obedience school as your sister’s hairdresser’s cousin’s Schnauzer. No amount of networking or glad-handing will save you.  

No firm will stand idly by as you continue to lose their money.

How to become a proprietary trader

If the last section hasn’t scared you off, then maybe proprietary trading is a good fit for you. There’s a difference between prop trading jobs and joining a prop trading company as an independent trader.

As I’ve mentioned before, a prop trading job is often extremely difficult to land and usually comes about through college or business school recruiters who go after the best students of math and finance. 

But literally, anyone can join the growing legion of independent proprietary traders by finding a prop shop that offers capital for a monthly fee or will offer you an account after you pass a trading evaluation.

Some of these types of firms should be avoided, particularly those with really large monthly fees and limited training, but some offer excellent opportunities to learn and profit.

To make it easier for you to choose a prop trading firm, I’ve reviewed the best firms on the market. You can read all about them here: Best Prop Trading Firms