If you’re not familiar with prop trading, it’s essentially a way for traders to get funded by a firm and trade their money. This is typically done in exchange for a cut of the profits. Although prop trading sounds like a great thing since you can start trading with little to no capital, there are some disadvantages that many people overlook. Here are some disadvantages to consider before you sign up with a prop firm-funded account provider.

Trading Regulations

trading regulations prop firm-funded account

When you trade with a prop firm-funded account, you’re trading someone else’s money, which comes with strings attached. You are expected to make profits for the firm and follow all their rules. There are restrictions on what strategies you can use, how many trades you can make per day, and a monthly minimum profit requirement. If you fail to meet their expectations, they will take your account away or penalize you.

The trader must adhere to the trading policies defined by the prop firm. For example, CFD traders must maintain a minimum account balance, known as the Minimum Account Balance (MAB). The MAB provides collateral for trades that may not be settled on time.

There are also restrictions on a trader’s ability to earn money through excessive risk-taking. Firms set limits on the size of their traders’ positions (also known as lot size limits) and the amount of money they can make or lose on each trade (also known as drawdown). A trader must also stick to certain guidelines to ensure consistency with the firm’s own risk management policies. This includes trading within specified hours and sticking with approved instruments/markets.

The Profit Split

the profit split prop firm-funded account

One of the most common and profitable ways to get involved with a proprietary trading firm is through their funded account program. Firms that offer these programs allow traders to trade with their money instead of their own for a percentage of the trader’s profits. These programs take many different forms but generally revolve around the same concept: split your profit with the firm in exchange for funding.

Each prop firm has different percentages at which they take your profits, but the majority are around 50/50 or up to 80%.

While profit splits can be a great way to get started and provide an opportunity for those who may not be able to fund an account on their own, some disadvantages should be considered before deciding on whether or not this is the right path for you. The biggest drawback is that you will never make as much money as you would if you were trading your own money at the end of the day. Let’s take a look at an example:

If you are with a prop firm that offers a 50% profit split, no matter what amount of profit you make, you are only eligible for 50% of that profit. Let’s say you make $1,500 profit on a funded account, you request for a withdrawal and 50% goes to the prop firm, and 50% to you, that means you have earned $750 in profit and the prop firm has earned $750 in profit. Both you and the prop firm-funded account provider make money off of your skill.

However, if you were to trade your own funded account, where you equally make a $1,500 in profit but this time, it would be a 100% yours and yours only.

You might be thinking that a prop firm gives you access to bigger capital, and yes that may be true, but you may not be factoring in the drawdown limit, specifically, the daily drawdown limit, which limits a trader to how much they are allowed to lose through running trades (otherwise known as floating equity) or closed trades (also known as account size), and this depends on prop firm to prop firm. A solution to this, is Funding your own account, you will be able to trade your own way with no trading restrictions and rules to abide by, you will have the chance to trade with much bigger leverage up to 1:1000 as seen with some brokers. All this eliminates pressure on a trader which definitely helps in the long run, but not all traders cope with higher leverage as that tends to promote a “gambling” approach to trading, the typical “go big or go home” mentality, also not all traders can afford to fund their own account, so it is best to choose a firm that has no daily drawdown and rather a maximum overall drawdown, it is also best to understand the meaning of drawdown to profit ratio and choose a firm that has if not no daily drawdown, then at least a high daily drawdown.

Drawdown to Profit ratio

drawdown to profit ratio prop firm-funded account

The drawdown to profit ratio is the most commonly overlooked thing when trading with a prop firm. Basically, this shows you whether the chances of reaching a profit target are easier than violating a daily drawdown limit and vice versa. First, you figure out what your daily drawdown percentage is, which is commonly 10%, and your profit target, which is also commonly set at 10%, this means you have a drawdown to profit ratio of 1:1, so for every $1 of drawdown allowed, you have to make  $1 in profit.

Using FTMO as an example, based on their max drawdown being 10%, and a profit target of 10%, we can see they have a drawdown to profit ratio of 1:1, we calculate this by taking the profit target and dividing it by the max drawdown whereas MyForexFunds, who operate on a 12% max drawdown and an 8% profit target has a drawdown to profit ratio of 1:0.66 where we take the 8% profit target and divide by the 12% max drawdown to give us the drawdown to profit ratio.

The same applies to the daily drawdown, and I advise that you focus your attention on that daily drawdown as that is what takes traders out mostly

Greed

greed prop firm-funded account

Greed is an essential part of your trading psychology, but it will hinder your progress if not appropriately controlled. If you’re trading a funded account, you will be well aware of the potential returns of your trading strategy, and when you’re live on the markets, this potential can go to your head.

You’ll find yourself wanting to trade more contracts than usual to make more money, which can result in over-trading. Over-trading means that you’re making too many trades, and they can almost always be avoided by staying calm, keeping a level head, and sticking to the plan. Here are two things I’ve learned from my own experiences:

The world of prop trading is filled with people who are just as eager to make money as you are but far less interested in building a long-term profitable system. This leads to emotional decisions like “should I trade my full-size position for an additional short?” or “should I stop trading for the day or continue taking more positions?” These questions lead many traders to take unnecessary risks that have consequences later down the road. When people feel pressure from their peers or fear losing out on profits they would’ve made if they had acted differently earlier on, they will often make emotionally driven decisions. These hasty decisions can have high negative consequences down the line when the risk is not worth it.

You’ll trade more frequently when your account is small; however, that doesn’t mean your profits will be higher when you trade more often. More frequent transactions put you at greater risk because each trade has smaller profit slivers than larger trades (trades being equal). It becomes easy for emotion to take control and cause us to make poor decisions. Even if we don’t act on those emotions, our reactions will likely cost us large profits if trades don’t go our way and we have trouble properly managing risk forward.

Excitement

excitement prop firm-funded account

Another disadvantage of trading on a prop firm-funded account is the excitement it induces in you can lead to excessive risk-taking. You may take unnecessary risks, leading to a substantial loss and even blow up your account. If you get too excited and start taking unnecessary risks, you could make costly mistakes, lose focus and completely miss out on an opportunity. You may also find yourself over-trading, leading to more losses than necessary. We see this most commonly with FTMO traders who trade with extremely high leverage, and high lot sizes, where the minute a trade goes against them, they violate a trading rule, only to start from the beginning and have to pass the 2-phase program, sound familiar?
This is the typical “go big or go home” mentality.

Fees and Commissions

fees and commissions prop firm-funded account

When you trade a prop firm-funded account, you will inevitably face the issue of fees and commissions. You may be charged for inactivity if you do not reach a certain number of trades per month. Depending on the amount you have to pay, it could wipe out your profits and make the whole trading process not worth it.

What’s worse is that when you trade with a prop firm, the cost of the commission might be higher than what other traders would pay. This could mean that you will have to pay more to get the same results as someone trading on their terms. This can be a big problem because it can lead to losses rather than gains. The fees and commissions are among the most significant disadvantages to consider when prop firm-funded accounts.

Enjoyed this article? Don’t forget to hit that share button above! Read this article next, Are prop firms legit, though?

 

 

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