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What is proprietary trading or prop firm?

Updated: Jun 8

The Forex market has seen a meteoric rise in the last 5 years of the prop firm industry. It has taken the markets by storm. If you have experience in trading at all and have not heard of ‘prop trading’, chances are you have been living under the proverbial rock! In this article, I am going to discuss exactly what prop firm trading is. The different models, the pitfalls, the challenges, and of course the advantages.

Before I get into the detail let me explain the origins of the prop firm industry. The prop industry has been in existence for decades. My trading journey began back in the late 80s as a floor trader in the trading pits in the City of London. Open outcry.

Traders shouted and screamed their trades at each other all day. We were literally throwing hundreds of millions of dollars around at the flick of a wrist. It made many of us a lot of money. I recall one of the media outlets at the time coining us as the ‘Thatcher boys’. Referencing the huge money that we were earning at such a young age. We were the original Yuppies.

Image of trading pits in the 80s

But like most things, all good things come to an end. By the turn of the century, these open ‘out cry’ pits around the world were closing down as the digital age took over. Many of these young traders, that were used to earning vast salaries and bonuses, very quickly, found themselves with nothing to do all day long.

Some retired and played golf, some went onto drive mini cabs and others opened up bars in Ibiza and spent the subsequent years drinking away their profits! But for others, trading was in the blood.

The prop firm industry took off.

Many of the young millionaires set up these so-called ‘prop shops’. They rented some office space, some desks, and some screens and gave a lifeline to the now-unemployed trader.

The trader would have to pay a fee to sit at the desk and use the prop shop facilities. The prop firm owner knew a good trader when they saw one. Usually, because they had been on the other side of their trades in the pits. So they would offer the young trader the funds to trade and agree on a percentage split of the profits. This also opened up the trading world to those from the outside looking in.

Roll on 15 years, the prop firm industry has never been stronger. It’s just very different. So, how?

Prop firms today offer aspiring traders the chance to qualify for a funded account. Usually, the trader will, for a fee, take a trading challenge on a dummy account, basically play money. If the trader passes the challenge they are given a “live account” and will share any profits they make with the prop firm.

Sounds too good to be true right? Well, yes and no.

There are many prop firms out there that basically make their money by all their aspiring traders failing the challenge and therefore losing their initial fee. They set trading rules that are so prohibited that they are designed for you to fail. Some offer unrealistic deadlines, expecting you to make a 10% profit on the dummy account in 30 days for example. Basically encouraging you to gamble.

As any professional traders know, you should only be trading when your strategy rules align. Being forced to trade is simply the wrong way to trade! Some rules will stipulate you need to trade a minimum number of trades in a time period.

As humans, we are brought up to believe the more you work the more money you should get paid. That does not necessarily hold true in trading. Often less is best! Some rules offer small equity drawdowns resulting in failure if your account drops by a small margin. But some traders get lucky and pass the challenge. The prop firm will give the live funded account. Or they say they do. They are happy to take the risk and happy to pay the winners profit split and fund this with all those other losers' fail challenge fees.

Sounds a bit like a Ponzi scheme I hear you cry.

Well, maybe. But should you really care where your profits come from? As long as you get paid your profit split then all’s good. The only concern you may have is if all the traders start to get funded and trade live, and make money, will the prop firm be able to pay you out before they go bust.

The other approach taken, and certainly favored by us here at The City Trader, is we want to see traders pass. We want to fund live accounts with traders that can prove they have what it takes. That they can control risk. Follow rules and maintain discipline

If the trader makes money, we all make money. The trading rules we use are straight forward, easy to understand with no hidden trapdoors. Of course, we want to make sure you don’t blow the firm's money so we have rules on risk. But realistic.

The same as back in the day in the Prop shops in London.

I have been trading all my adult life. The past 6 years taught 10’s of thousand of traders how to trade. The number one reason in my experience why traders fail is that they are underfunded.

They are trying to live the dream by starting with a $500 or $1000 trading account. When they realize the realistic returns on a small account are so low they gamble and more often than not end up blowing up the account. They either give up the dream or go again.

As I said, there has been an explosion of props firms in recent years. So I suggest you do your due diligence. Pick one that suits you, your ambition, and your personality. And my big advice is to get educated. Or else you will only be blowing prop firm challenges and associated fees instead of the small account. The end game is the same. Death by a thousand cuts.

The prop firm industry has given the potential for those that limited accounts to truly get on a path to a professional trading career. If you can maintain discipline, follow rules and stay grounded then this could be your lifeline to financial freedom.

Stay safe.

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