What Is Proprietary Trading: What, How, Earning Potential & More

Imagine working at a company that gives you their money to trade with. In doing so successfully, you are allowed to keep a percentage of the profits, which provides you with the opportunity to earn …

what is prop trading

Imagine working at a company that gives you their money to trade with.

In doing so successfully, you are allowed to keep a percentage of the profits, which provides you with the opportunity to earn a much higher amount in commissions than any other job in the financial world.

However, there is no middle ground, meaning if you lose money while trading, you get fired.

Welcome to the world of proprietary trading.

Also known as prop trading, this type of trading is not as familiar to the average person, unlike forex or crypto (although there is crypto prop trading, and forex prop trading).

This unique trading field gives you a more substantial earning potential at a much earlier stage of your career than other finance jobs.

To make sure you get a comprehensive understanding of prop trading, I’ve written this article that covers everything from what prop traders do to how much they earn and everything else in between.

This will allow you to properly consider proprietary trading as a possible career option in your future.

What Is Proprietary Trading? 

What Is Proprietary Trading

Proprietary refers to ownership. Proprietary trading refers to banks or financial firms trading the market with their own money.

What makes proprietary trading different from retail trading is in retail trading, firms or banks trade with their clients’ money, thus, they only get a small percentage of the profit made from each trade.

The reason these institutions favor proprietary trading is by using their own money, firms get to move up from being the middleman, and, therefore, keep a lot more of the profits earned in each trade.

Banks and other financial firms are always looking to make a profit, and this method allows them to exceed the profit margins they make when trading with client money.

Due to the pool of information available to these businesses as a result of proximity alone, they have the upper hand in comparison to a regular trader or any average person.

They also have access to exclusive software that gives banks and similar firms a better idea of the market through complex and sophisticated modeling.

Most of which, you will get if you’re accepted into a prop trading firm.

Is Prop Trading Illegal? 

The answer is a cautionary yes, with a but. The but is that online firms such as TopStepTrader, FTMO, etc. are completely legal.

To properly address the question that everyone’s curious about, we first need to answer the question – What is the Volcker Rule?

In an attempt to prevent the 2008 Global Financial Crisis from reoccurring, a federal regulation called the Volcker Rule was passed in order to stop banks from partaking in certain high-risk investment activities that caused the GFC.

The rule was named after the previous Chairman of the Federal Reserve, Paul Volcker.

The Volcker Rule prevents short-term prop trading of certain assets and their options using a bank’s own funds if these activities are not beneficial to their customers.

This is a great video explaining it:

The rule came into effect on the 1st of April 2014. All relevant financial institutions were given until the 21st of July 2015 to fully comply with the new regulations.

On the 30th of May 2018, the Federal Reserve voted to reduce the limitations placed on banks by the Volcker rule.

Finally, on the 25th of June 2020, FDIC Chairman Jelena McWilliams announced revisions to the Volcker Rule.

While the initial version of the Volcker Rule severely limited a bank’s ability to engage in proprietary trading and sponsoring hedge funds and private equity funds.

The revised version permits banks to invest in venture capital funds and credit funds as long as certain safeguards are in place.

These safeguards include restricting firms from making investments that directly conflict with what would benefit the client.

So, private proprietary trading firms, such as TopStepTrader, FTMO, The5%ers, etc. are, in fact, completely legal.

What Do Prop Traders Do?

Prop traders trade on behalf of a firm while using its capital. These trades are placed using well-practiced strategies that traders learn through specialized training.

Using the online platform provided by the company, experienced traders are free to work whenever they like as long as they meet their targets.

The lack of strict hours makes this a very appealing job for many.

Traders use statistical analysis and technical indicators on the company platform to plan and make trades throughout the day.

Profits are generally split between the trader and the firm, where the company determines the exact ratio. Usually, the trader will keep 50% – 90% of profits

How Do Prop Traders Get Paid?

How Do Prop Traders Get Paid

There are three common payment structures on how firms pay prop traders.

Variation #1

In the first and most common variation of payment structure, your prop firm will take a percentage of all the profits you make.

This cut can range anywhere between 10% – 50% of total profit.

The amount of capital you are provided with is based on the skill and experience you present.

This means a trader working in this payment structure will make a majority of their income from their trading profits.

This is the most well-known and beloved form of prop trading, and the one I’ll talk about most throughout this website.

Two things to note and check with your firm:

  • Firms might also charge traders a seat and software fee.
  • Sometimes traders are required to put up some capital and are usually required to pay for trading training by the firm’s experienced traders.

Variation #2

For the second variation of prop trading, the profits your firm takes will be next to nothing, resulting in your keeping close to 100% of the profits you make.

Here, the trader is required to provide a more considerable amount of capital upfront to the company to be leveraged for the firm.

The firm makes its money by charging training fees, higher commissions, and seat and software fees.

Variation #3

For the final variation, we have floor traders. These traders work much longer hours in the office, anywhere between 10 – 12 hours, and work for a fixed salary.

This is still prop trading since they are trading with the firm’s money, but a much more traditional form of it.

One Thing In Common For All Three

For all three variations, traders receive large amounts of bonuses depending on their performance.

Plus, experienced traders have the ability to work from home at hours that suit them. 

How Much Do Prop Firm Traders Make? 

  • At the lower level, prop firm traders usually earn upwards of $80,000.
  • In the mid-range, we have more experienced traders who are making north of $102,000.
  • At the higher end of the life-long traders, or simply very talented ones, can earn over $165,000.

How Are Prop Traders Taxed? 

Due to the unique circumstances under which prop traders trade-in, they may have special tax compliance needs that need to be met.

When a prop trader works with a firm, they can do so in the capacity of an LLC member, an independent contractor, or as an employee.

Independent contractors can report fee revenue and deduct expenses for their business, including anything to do with a home office, if they qualify.

The rest (LLC and employee) is considered net income that is charged under the self-employment tax, which they can also deduct health insurance and retirement from.

Do Prop Traders Need A License?

Do Prop Traders Need A License

If you want to work for one of the popular online proprietary trading firms (such as FTMO, TopStep, etc.) you do not need a license.

However, to trade professionally in an office of a big firm, you will usually need a license.

The licensing requirements vary depending on the series that you are looking to qualify for. For example, to obtain a Series 6 or Series 7 securities license, you will need to be sponsored or employed by an established broker.

Each of the licensing exams is difficult to pass and will need thorough preparation and study.

Note: Working at a licensed broker is a great advantage as they usually provide in-house training programs to help you pass the exams.

How Do You Become A Prop Trader?

For online proprietary trading firms, you will need to pass certain challenges (though some offer instant funding) to get accepted to different levels of funding.

This could be reaching 10% in profits within 30 days. Or simply staying profitable for 10 days. Each firm has its own challenges.

Once you pass them, you will start out with a certain amount of funding, that you can then increase as you pass more difficult challenges.

However, if you happen to cross a loss limit, you will be kicked off the firm, or at least, get decreased funding.

For traditional proprietary trading firms, your foundational knowledge and expertise are what will determine the trajectory of your prop trading career.

Although certain education qualifications are essential, they will by no means be a limiting factor.

In terms of academic qualifications, you should aim to have a bachelor’s or master’s degree in the field of finance, maths, statistics, economics, or banking.

If you do not have a degree, you can take specific online courses to obtain the academic knowledge required to get started in prop trading.

Skills To Have To Be A Successful Prop Trader

It is crucial that prop traders understand the derivatives market and its dynamics.

The majority, if not all firms (both online and traditional), provide new hires with intensive training on the job with their most experienced traders to learn about their most profitable trading strategies and approaches.

Therefore, lack of experience will not be a barrier. However, traditional prop firms do highly favor those with internships in banks, brokerages, or asset management companies.

So, the skills you should have to be a successful prop trader:

  • Analytical and trading skills.
  • The mathematical ability for scalping, arbitrage, and day trading.
  • A detailed understanding and experience of employing successful strategies for arbitrage trading.
  • A thorough and in-depth understanding of the financial market along with competent asset management skills.
  • Knowledge and experience in money and risk management skills.
  • The initiative to carry out your own research of market behavior and plan daily trading strategies.
  • A high level of knowledge of all or most of the different terminology and methodologies of predicting market movement and executing profitable trading strategies.

Pros & Cons Of Proprietary Trading

The Pros Of Prop Trading

  • You can receive hands-on training from experienced and successful traders who will help you become more profitable in a short time span.
  • You will be given access to more capital to trade with compared to trading on your own.
  • Trading through a firm has lower costs than doing it on your own.
  • Prop traders have freedom because they have no client telling them what to do. The firm gives them money and asks them to make profits however they see fit.
  • The earning potential for prop traders is much higher than the average trader.

The Cons Of Prop Trading

  • As more firms go online, trading floor seats are dropping in numbers. Since the trading floor is where most new employees start, it is becoming more and more difficult to get hired due to the lack of empty seats.
  • The advancement of retail technology is slowly taking away the advantage previously held by prop traders when it came to trading platforms and internet speeds.
  • Retail day traders are able to get better commission rates after negotiating with their broker in comparison to the commissions charged by prop firms.
  • It can take several months to become profitable, and since some firms only pay in commissions, you might not have an income for a period of time.
    • This also means that your income is not guaranteed, as profits can fluctuate consistently throughout the years, months, and days.

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