What Is Prop Trading? Everything You Need to Know

prop trading

Are you looking to find success in the financial markets? If so, you may want to consider trading.

From banks to individuals, trading can be one of the most financially rewarding decisions you can make. Specifically, proprietary trading can give you high rewards.

Below, we’ll explain how propriety trading works, the benefits and disadvantages to consider, and 3 popular strategies to be aware of.

What is Prop Trading?

Proprietary trading involves making trades using a company’s money. The traders will use the company’s money because they’ll be implementing the business’s strategy into their trading decisions.

With the company’s funds in hand, the traders will execute the trades without taking on any risks. And traders from around the world can work with the firm.

In the meantime, companies benefit from the traders by maximizing their returns. They can delegate specific tasks to certain traders, which allows them to create specialized trading departments within the firm.

How Prop Trading Works

How does prop trading work? First, the trader will reach out to a company. The company will then coach the trader on its processes and rules for trading. Each company has its own approach.

A trader who wants to work for said company will get the software and hardware necessary to begin the job. With this software, they can practice engaging in day trading. Many companies will use a demo account.

Traders who familiarize themself with the company’s methods and successfully prove that they can execute good trades will then have access to company money. Let the trading begin!

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Prop traders make their money by taking home a portion of the earnings they make for their company. Each company will have a different amount of earnings that each employee can get.

New prop traders who want to get in the business should look for firms that have a simple trading platform and a solid reputation. Higher returns than other firms are always a plus.

Benefits of Prop Trading

Like any other trading method, prop trading has its advantages and disadvantage. Let’s first look at what you stand to gain from prop trading.

Use Professional Tools at no Cost

Often, traders who work on their own will have to purchase their own software and trading platforms. To get a competitive edge, they’ll likely have to spend more.

As a prop trader, you won’t have to be financially responsible for the tools you use. And the software, data, and platforms you have access to what may be some of the most advanced in the industry. All you have to do is earn a profit.

Face Less Risk

When you invest independently, all of your money is on the line. You could potentially lose everything you invest. With prop trading, the bulk of your investment will be with company money.

This means that you face substantially less risk, but you still have the opportunity to make the returns that you want.

This is good news for most traders, considering that the majority of day traders earn a net loss, according to data from CNBC.

Prop trading will cut the chance for losses without affecting your ability to make gains – that’s a formula that most traders won’t object to.

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Save on Trading Costs

Trading alone often means you’re subject to high brokerage fees. Trading for a company can seriously lower these costs, as you’re trading on a large scale. Institutions also can have lower fees since they generate a larger volume of traders.

Day traders will appreciate the lower costs of trading, especially when they make multiple trades per session. Avoiding high fees can be hard to do when you’re trading alone.

Drawbacks to Prop Trading

No industry is perfect, prop trading included. Below are a few disadvantages of prop trading to keep in mind.

Follow Strict Regulations

You stand to make a large amount for the company and yourself as a prop trader. Because of this, you have to follow strict regulations set by both the company and the government.

Consider the Volcker Rule. This is a federal regulation that prevents banks from engaging in prop trading, although there are certain loopholes that allow banks to participate in prop trading in some cases.

It’s rules like these that you should be aware of should you decide to get involved in prop trading.

Not to mention, each company will have its own standards. If you can’t hit your profit targets or you’re not a consistent trader, don’t expect to stay long.

Companies hire traders to earn a profit. When traders don’t deliver, the company no longer sees them as worth keeping around.

May Limit Investment Options

Since you’re trading other people’s money, you have to play by their rules. This means you could face limitations on what you’re able to trade.

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For instance, you may work at a company that only allows you to trade stocks. If you want to trade futures, you’re out of luck.

This depends on your trading expertise and what you’re looking to get out of your prop trading experience. If you’re a beginner trader, you may not mind focusing on just one asset class at a time. But more experienced traders may want more options.

Experience High Pressure

Consider prop trading to be the big leagues. Traders who let their emotions get to the better of them may not be ready for this challenge.

Prop traders are given all of the resources needed to succeed, so their managing companies then expect them to deliver. Traders will have to work diligently and learn quickly to remain an asset to the company.

Above all, traders have to stick to the strategy of the company they’re trading for. It’s necessary to put their opinions aside and get the job done.

Getting Started with Proprietary Trading

Prop trading could be a profitable career move. Now that you’re aware of how it works and what you stand to gain, why not explore the prop trading opportunities available?

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