Are prop firms legit, though?
Prop trading is a legitimate and profitable financial strategy, but it’s not for everyone. You need a solid grasp of the markets, sound risk management practices, and a dedicated system to become successful.
Prop trading firms are not scams or get-rich-quick schemes. They’re investment firms that help people profit from their market knowledge and experience.
The top prop firms will have a proven track record of successful trades and help you develop the skills to succeed as a trader. Proprietary firms are often misunderstood. So what’s the truth about these firms? We’ll try to get to the bottom of this question in this article.
What’s the history of prop firms?
Proprietary trading is the process by which firms trade for their account. Proprietary traders can be found at investment banks, hedge funds, and even large corporations.
Proprietary trading was one of the leading causes of the 2008 financial crisis. Proprietary traders at mega-banks like Goldman Sachs and J.P. Morgan gambled billions of dollars in risky bets that ultimately led to the financial system’s near-collapse.
As a result, the Dodd-Frank Act was passed (Dodd-Frank Act 2010), which restricted proprietary trading to reduce systemic risk in the financial system and prevent future crises. The Volcker Rule prohibits depository institutions from engaging in proprietary trading except under certain circumstances typically only available to larger banks (Federal Reserve Board 2015).
Even after the passage of Dodd-Frank, many people mistakenly believe that prop trading is illegal for anyone other than big banks and hedge funds. As a result, some people avoid proprietary trading altogether, thinking it’s the only way to go if they want to avoid legal trouble.
Prop trading, as it’s practiced today, is entirely different from prop trading from even just a decade ago.
How do prop firms work?
Prop firms focus on high volatility, high-risk options, futures, forex, and CFD trades. Their goal is to find out-of-the-money possibilities to turn into quick profits.
They offer an alternative to big banks for people who want access to proprietary trading without all the hassle of working at one of the big institutions.
The good news is that anyone can open an account at a prop firm—you don’t need to be a professional trader or a millionaire. It would help if you had some cash and a risk appetite.
Prop trading firms do precisely what their name implies; they provide funding for traders. The firm provides capital that the trader can use to place trades in exchange for a portion of the profits from those trades. Prop trading firms are not your typical stock and options brokerages; they typically don’t charge high commissions, and they allow their traders to take on much more risk than a traditional brokerage firm would permit.
Prop trading firms will cover your losses, but only if you play by the rules. Most prop trading firms have strict trading parameters that limit the amount of risk you can take on by limiting draw-downs (amount of loss over time), stop-loss requirements (a point at which you must exit a losing position), overnight positions (positions held overnight or longer) and news releases. Be aware of these parameters when starting with a prop firm.
Yes, prop trading firms (also called prop shops) provide financing to real-money traders. However, they aim to protect their capital in most cases. Prop firms make their money by charging a fee, called the spread, on each transaction.
Is it difficult to become a profitable prop trader?
Trading is difficult. Everyone knows that especially prop trading.
But to be successful at prop trading, you must have the right mindset and a proven strategy.
A prop firm is essentially saying, “We’ll provide you with the capital, you trade it for us.” In return for providing the capital, they are taking a cut of your profits.
The beauty of it is that you don’t have to go through the tedious process of raising money from friends, family, or VC funds, nor do you have to put in substantial amounts of your cash (although many traders do). You are trading for a third party providing the funds and allowing you to make a profit.
The other side of the coin is that their risk is very low. They limit your parameters and manage your account to protect themselves from significant losses. They also require that you adhere to specific risk parameters as well. If your account exceeds those parameters, they will close your account and take away your initial sign-up fee.
Indeed, prop trading is not for everyone, but it is still an option for many people. If you want to be a prop trader, know that your first step is to pass a trading test to qualify for a demo account. The test’s purpose is to ensure you have the skills and knowledge necessary to trade and manage risk appropriately. However, prop firms like BLUFX let you trade live accounts right away without demo challenges.
Remember that these are just guidelines, and some firms may have slightly different expectations. The most important thing to remember is that if you want to be successful as a prop trader, you need to demonstrate profitability for your trading track record over a long period.
They aren’t scams, are they?
Setting yourself up for success as a prop trader is all about the details. It would be best if you were willing to work hard, be competent, and work constantly. If you can’t do that, trading with a prop firm is not for you. But if you can, you’re already ahead of the game.
Please understand what your firm is offering before beginning. Is it access to free education? Are they providing support? Are they giving you a set of rules that you must follow? If so, know those rules inside and out before trading begins.
Finally, know your limits as a trader. If you have never traded on your own before, it might not make sense for you to start on your own without any supervision or guidance. Start with an educational site like FX Empire or Babypips and build up your skills first!
That said, it is possible to have a profitable experience as a prop trader. As long as you are realistic about your risk tolerance and expectations, make sure you understand your trading parameters and are willing to learn from your mistakes. Prop trading firms can provide instant funding and offer an educational experience that will help you to understand the markets better.
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