It is very easy to get caught up in the lifestyle portrayed by so-called traders who claim to make five to six figures every month by trading a few hours a day.
While it is true that you can make money that way by working with legit prop firms, it is quite easy to get scammed in the world of trading if you are not careful.
Due to the unregulated nature of today’s prop firm market, anyone can attempt to become a trader at an online firm, which has led to a rise in illegitimate prop firms that scam people out of their hard-earned money.
To help you navigate these treacherous waters, I’ve put together this article to cover how prop firms work, how best to work with them and what to look out for to protect yourself from being scammed.
If that sounds helpful, let’s dive right in.
First, What Is Prop Trading?
To know if a prop firm is a scam, you first need to understand what prop trading is and what prop firms do.
Simply put, prop trading occurs when a prop firm hires a prop trader to trade with the firm’s funds.
A prop trading firm is a financial firm that uses its own capital to invest in the markets. For example, let’s say a prop firm has $10 million.
That funding is split amongst all the prop traders that trade with the firm.
Prop traders who work for prop firms are usually contractors, unlike traditional brokers employed by a company.
The prop trader has to abide by the firm’s trading guidelines, and all profits are shared between the trader and the firm, with the majority going to the trader.
Are Prop Firms A Scam?
While this is a common question that is frequently asked about today’s prop firms, you first need to understand why this question exists.
Back in 2008, the institutional prop trading firms, mainly the big banks, were blamed for causing the Global Financial Crisis.
As you may be aware, the entire financial market crumbled, billions were lost and even some lives, all due to several highly questionable trades carried out by prop firms at that time.
To prevent history from repeating itself, the Volcker Rule was implemented, making it all but impossible for banks and other financial firms to run prop shops like they used to.
As a result, most of those firms stopped prop trading altogether for legal reasons.
While these regulations applied to banks, the Volcker rule does not apply to all the independent prop firms that operate today.
Today’s prop firms are very much removed from the banking world and are nowhere near are regulated. Therefore, these online prop firms are completely legit and not a scam.
However, due to the lack of heavy regulation, scammers do exist in the industry that try to take advantage of the current market.
There are several ways to separate the legit prop firms from the scam prop firms, which I will cover later in this article.
How Do Prop Firms Work?
Here is a quick explanation of how prop firms work.
To join an online prop firm as a trader, you will have to pay an upfront fee to either successfully complete their verification challenge with a funded account, which can be live trading or a demo account.
Your aim is to trade with this account for the duration of the challenge, which usually go for 30 days, while sticking to their trade and profitability rules.
The outcome of the challenge will determine your future with the firm.
These challenges are done remotely and, if the trader uses a live account, they get to keep a 70% split of the profit.
Most, if not all, legit prop firms do business this way and have been doing so for a long time.
While this was only available to fund managers in the past, it is now becoming a lot more accessible to retail clients in recent years.
How Do Prop Firms Make Money?
When a prop firm is legit, they make money in the following two ways: split the profits between the firm and the trader and run continuous funded account challenges.
The first method of profit splitting is the essence of what prop trading is and how firms and traders make money.
However, not all traders are profitable, which is a bigger problem for the firm that has overhead costs than the trader.
Therefore, selling funded account challenges provides them with another revenue stream.
How To Spot If A Prop Firm Is A Scam?
While it can be easy to trust the most popular prop firms around and assume that they are legit, it is always good to do your due diligence because, at the end of the day, no one wants to get scammed, and that is always a real possibility when money is involved.
There are stories of newbie traders who have started a prop firm challenge as part of the verification process but ended up accumulating significant losses in their demo account, which, as you’d expect, isn’t real money.
However, the firm then offers to scratch all their fake-money losses if the trader pays real money.
They offer to re-train these inexperienced traders with promises of becoming highly successful traders and string them along as long as possible.
To avoid making the same mistake, look out for these signs to spot if a prop firm is a scam:
- A few, or zero, reviews on reliable sites such as Trustpilot.
- A lot of reviews on reliable sites such as Trustpilot, but all seem awfully biased, and all published around the same time (fake reviews).
- Unprofessional website that shows lack of effort, with terrible user experience and spelling mistakes.
- No real social media presence, such as a YouTube channel or Instagram account.
- Very little content is available on the internet regarding the firm.
- It sounds like a get-rich scheme with large amounts of funding and easy to pass challenges.
- Little to no customer support
How To Avoid Being Scammed By A Prop Firm?
There are only two real ways to stop yourself from getting scammed by prop firms.
The best way to confirm if a prop firm is legit is by scouring all the reviews on sites like Trustpilot to see what the public has to say about their experience with a particular firm.
Make note that you need more than a handful of positive reviews to know that a prop firm is legit.
Next, making sure to trade with the top prop firms, such as FTMO, MyForexFunds, etc. (you can check out my top 12 best prop trading firms) is a sure-fire way of protecting yourself from being scammed.
While it isn’t a guarantee that these big firms won’t just decide to not pay out or squeeze traders out of their funding accounts, firms that have taken the time to build a good reputation have done so with the intention of being around for the long run.
Finally, to avoid being scammed by prop firms, traders should diversify. Just like a good trading strategy involves diversification, traders should trade separately with their own capital as well without putting all their eggs in one basket and solely depending on their funded account for an income.
The Safe Way To Use Prop Firms
To use prop firms safely, I recommend working with not just one but multiple prop firms simultaneously.
On top of that, you should also be trading on your main account using your own capital.
The reason I highly suggest you follow this strategy is because using multiple legit prop firms helps you hedge your risk to any one of the firms you join.
This way, you won’t have everything in a firm that ends up closing down, leaving you with nothing.
While nothing is certain when it comes to trading, the following will help reduce your risk:
- Join multiple firms, at least 2, and get funded accounts to trade with.
- Every month that you do end up profitable use it to compound your main account. Try not to leave it in your funded accounts.
- Learn to use software that helps you automatically copy all your trades across your accounts using tools like MT4 Copier.
- Try and join as many prop firms and get as many funded accounts as you can sanely manage.
- Rinse and repeat.
The Pros Of Prop Firms
The definition of prop trading is for a firm to provide capital to its traders to trade with. This means, with all the capital coming from the firm, traders don’t have to risk their own money to earn profits.
While there are entry-level fees, these are a fraction of the funded account you will be trading with.
Plus, prop firms usually come with deep pockets, at least much deeper pockets than a trader has by themselves.
This liquidity provides traders with unprecedented freedom and excellent trading conditions.
As the trader continues to perform well, they will be trusted with more significant amounts of funding, leading to huge earnings through profit splits.
The top quality, well-respected prop firms value professionalism and reliability.
Therefore, traders are set up with structured trading and risk management plans that are strictly monitored, or the trader risks losing their account, regardless of how successful they are.
Firms provide guidance and supervision through their more senior and experienced traders.
Traders do get to move away from the rigidity of office trading and employ day trading strategies, as long as they remain with the trading parameters defined by the firm they work with. These parameters can also change between firms.
While the traditional trader is restricted to office hours, online prop firms operate all day.
This allows traders to pick their trading hours while implementing self-determined strategies and trading frequencies.
This also provides traders with an excellent work-life balance by not being constricted to specific working hours.
The Pros Of Prop Firms
Every prop firm has its own rules and regulations when it comes to trading strategies, and they are quite strict about traders adhering to those guidelines as well.
It doesn’t matter how profitable your strategy happens to be; if it doesn’t align with the prop firm’s views, the trader can lose their funded account and may never be able to trade with that firm again.
Before joining a prop firm, you must do your due diligence to determine if your strategy aligns with that of the firm.
You can then decide whether you are willing to modify how you work or look for another firm altogether.
Finding the right fit may take time, so don’t get impatient and join a company for the sake of being able to trade, only to get kicked out or be restricted in what you do.
Let’s say you put in the time and research and found a prop firm that aligns with your views and strategies. There is no guarantee that you will be able to join them.
Every firm has a verification process that new traders have to go through to evaluate their profitability and strategies against the firm’s guidelines.
This is not a fast process. It is also not a guaranteed process.
It is easy to miss certain rules when you trade, only to be called out by the firm and be refused entry despite you having paid to enter this verification challenge.
Remember, this is their money you are trading with. They have the right to pick and choose who they wish to trust with that money.