Commodities on the market aren’t always liquid. Every seller won’t always find a buyer. And when you’re buying, not everyone is selling. That is why flow traders are important.
Flow trading is one of the oldest ways through which big investment banks make their money. Flow traders help clients perform trades and look to make money through commissions and the spread.
But, while flow traders trade for clients, prop traders trade for their own firm.
Here’s an interesting fact about the two professions – pre-GFC flow traders would aspire to be high performing and highly profitable prop traders.
SO, let’s take a look at what each trading style entails and what separates the two. This is prop trading vs flow trading.
What Does A Flow Trader Do?
Flow trading refers to when a firm uses their client’s funds to invest in a financial asset such as commodities and its derivatives, bonds, stocks, currencies or any other financial instrument, without using the firm’s own funds to do so.
A sizeable portion of profits for investment banks are generated from flowing trading.
Firms also take part in flow trading to be able to boost their own profitability through prop trading with the information they collect from client activities.
The Volcker Rule, introduced after the Global Financial Crisis, was created to restrict prop trading for traditional firms such as banks, which I will cover in the next section.
Flow trading firms are also able to earn a profit through bid-profit spreads by being the counterparty to be able to facilitate a client’s trade.
For an inexperienced trader or outsider, it can be easy to underestimate the difficulty of being a flow trader from the job description.
However, a flow trader’s role isn’t simply to execute an order given to them by their client or sales team, there is a lot they need to consider.
When a client rings the firm asking for a price to buy or sell a financial asset, a salesman will pass this request to the flow trader.
It is the trader’s job to appropriately price the deal and pass back onto the customer.
To appropriately price a trade the flow trader needs to factor in a few things:
- They will first need to speculate if the price of the transaction is within reach of the market to handle. Since they do have to try and accommodate all clients’ trade requests, flow traders will inevitably shoulder the risk for a long or short time. The quoted price to facilitate a client’s trade order must provide enough leeway to handle this risk.
- Secondly, while it can be tempting for a flow trader to quote their bid offer at any price, they need to be aware of that fact that there are plenty of other firms that can offer a more attractive bid offer to their client. If the flow trader’s quote isn’t acceptable, clients can easily shop around to find the best deal in their eyes.
What a flow trader shouldn’t have, or can’t have, is a stronger view or opinion on a particular trade as to whether they believe it will be a profitable long-term purchase.
Their main priority is to be facilitators to their clients’ buy and sell trades and try and make as much profit as possible across the spread.
While customers choose when they want to buy and sell financial assets and which firm they want to go with, it is the flow trader’s job to capture as much of the trading flow as possible.
This means they need to make sure that most of the trade calls that come through their firm gets executed in their firm. They have to offer a competitive bid-offer spread while mitigating risk.
Beyond buying and selling securities and financial assets on behalf of their firm’s clients, while earing commissions, a flow trader has to create or highlight strategies and ideas to institutional investors in the hopes of capturing higher trading flows.
What Does A Prop Trader Do?
Prop trading occurs when a firm provides traders with capital out of their own accounts to trade for profits however they please.
A prop trader acts as investor for the firm with the firm’s money – similar to a hedge fund but without using client’s capital.
Before the Volcker Rule was imposed, prop traders at banks were the brightest and best traders. In fact, people would get employed into the bank as a flow trader where they had to prove their worth.
From there, the best and brightest were handpicked to be moved up to prop desks.
However, it is widely believed that prop traders were at fault for the 2008 GFC, hence the introduction of the highly restrictive Volcker Rule.
While banks may have severely cut down their pro trading activities, there are plenty of trustworthy online prop firms you can join, such as FTMO and Topstep that provide traders with funded accounts to trade with.
4 Differences Between Flow Trading And Prop Trading
Some key differences between flow trading and prop trading are:
Flow traders use client’s funds to carry out trades on behalf of the client. Prop traders, on the other hand, do not work with client capital.
Instead, they use the firm’s own funding accounts to execute trades with.
Salary & Hours
On average, flow traders can earn around $120,00. Their role is salary based and their hours are limited to the trading hours of the firm they work in.
While flow traders enjoy relative job security and a stable income, their earnings are capped once they reach a certain amount.
Prop traders do not have salaries, unless you are lucky enough to become a floor prop trader at a traditional financial institution, such as a bank.
With the heavy restrictions of the Volcker Rule, these positions have all but vanished. Online prop firms are the best way to go.
Prop traders earn money buy getting anywhere between 50-90% of the profits they make by trading with the company account.
This means that a successful prop trader has no real limit to how much they can ear, making it a very lucrative career path.
However, while a prop trading is learning the ropes or struggling to make a profit, they can go for weeks with earning anything.
A flow trader gains employment through a standard job interview process. Online prop trading firms have a different approach to recruiting new traders.
To be able to work with a prop firm like FTMO, new recruits are asked to go through a verification process where they have to prove their ability to be profitable traders before being trusted with well-funded accounts to trade with.
When it comes to executing trades, flow traders do not get to have an opinion on a trade and how they believe each financial asset will perform in the short or long run.
They have to always be able to accommodate their client’s needs and look to make a profit on the spread.
A prop trader doesn’t have to worry about pleasing clients and facilitating their trades. Since they trade with the company’s capital, they are able to hold any position they like with the end goal of being profitable in the long run.
2 Similarities Between Flow Trading And Prop Trading
Prop traders and flow traders are different in almost every way. However, their main similarity would be in providing liquidity to the market, also known as market making.
A flow trader has to facilitate every trade for their clients to ensure the market remains liquid, aka investors can always buy and sell an asset on the market.
Due to the large positions prop traders take with their company funds, this also provides liquidity to the commodity that they are trading in.
Flow traders and prop traders need to be familiar with several commodities across multiple global markets.
A flow trader utilises this knowledge to hedge their bets when facilitating client trades and prop traders use company funds to implement strategies that involve several different markets to make a profit.