Proprietary Trading: How it Works, Benefits and Strategies

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Proprietary Trading: How it Works, Benefits and Strategies

proprietary trading

Prop Trading has become one of the fastest areas in the financial industry. Today, while the number of retail traders has jumped, many people are turning to prop trading to complement their income. They see it as a better option to make money in the financial market than simply running a retail trading account. 

This article will look at what proprietary trading is and answer some of the most common questions about the industry.

What is proprietary trading?

Proprietary trading, commonly known as prop trading, is a way of participating in the market without using your money. Instead, prop traders use funds provided by a third party, which hires traders locally and internationally. 

The company will find traders, coach them, test their skills, and then allocate funds to them to trade. After this, the prop trading firm will take a small cut from the profits that the traders generate.

The biggest challenge for prop trading companies is losses coming from its traders. To deal with this, these companies have rules to reduce the risk of losing too much money. At the same time, these firms use technology to monitor their accounts. 

The process of becoming a prop trader is relatively simple. First, the trader will sign up with the company by filling in a few details. Second, in most cases, the trader will talk with the account manager, who will guide them on the process. 

Third, they will now move to a demo account for testing. If they are approved, the company will fund them and the trading process will kick off.

There are many firms that offer proprietary trading services. However, Real Trading is among the pioneers in the industry, one of the largest and is recognized as one of the best prop trading firms (even the WSJ talked about us).

The firm lets individuals from across the world trade with its money. It also allows them to maximize their returns by hiring traders and establishing their specialized trading floors.

Why companies engage in prop trading

A common question is why companies use prop trading as an approach. People with this question argue that the firms could use these funds and operate as a hedge fund. However, there are several benefits of using the prop trading strategy.

First, the companies get a large pool of trading talent by using the prop trading strategy. For example, a company like Real Trading has thousands of traders who are engaged in the process every day. This helps it maximize its returns.

Second, when done well, prop trading can be a successful business strategy for a company. Finally, these firms get traders from around the world. In most cases, it is almost impossible for trading companies to make money using a different strategy.

Prop trading regulations

The prop trading industry is highly regulated in the United States, which explains why many companies avoid the market. One of the top regulations is known as the Volker Rule, which came after the Global Financial Crisis of 2008/9.

The rule banned FDIC-insured banks like Goldman Sachs and JP Morgan from engaging in prop trading. This rule happened after regulators blamed these companies for going against their customers. For example, a company like Goldman Sachs was blamed for recommending housing stocks while it was shorting them.

Prop trading also has rules about insider trading and market manipulation. For example, it is illegal for a prop trading firm to trade with inside information. It is also illegal for them to manipulate the market.

How do proprietary trading firms work?

Prop trading starts when a trader gets in touch with a company, in this case Real Trading. The trader will be introduced to the industry and then be coached about the company’s processes and its proprietary trading approach.

If the trader is interested, they will receive trading software and hardware. After this, you will be introduced to day trading, using the training platform as a demo account.

After all this, the company will give you an account with its money and you can start trading. You will get to keep a substantial amount of the money you generate. This amount differs from company to company. To get a better idea of ​​this, take a look at our partners’ day trading profits.

Ideally, you should select a prop trading firm that offers adequate training, has an easy-to-use trading platform, and one that has a long track-record in the industry.

How to get funded in prop trading

As mentioned above, prop trading companies use different approaches to fund their traders. For example, big prop trading companies like Susquehanna and Two Sigma provide funds to their employees. This means that you must be an employee of the company to receive funds from the company.

Other online prop trading companies like FTMO first take users through a trading challenge in a demo account. They then provide funds to people who pass the challenge stage. Other firms fund people automatically who pay a certain fee.

At Real Trading, the process starts by a trader paying $500 for the trading software and the hardware device that connects them to the market.

After this, the trader is taken through a comprehensive training process. They then use the demo account and are then funded when they pass the required objective. The trading capital provided also depends on the type of asset you are planning to trade.

Proprietary trading vs hedge fund

For starters, a hedge fund is a company where the manager raises money from investors and then invests or trades for them. They use their strategies to achieve these returns. In return, the fund manager keeps a certain percentage of the profits and also charges an annual management fee.

Hedge fund managers are some of the wealthiest people in the United States. They include people like Ray Dalio, Bill Ackman, and David Einhorn.


Prop trading is different from hedge funds for three main reasons.

  1. With prop trading, you don’t have a set of investors. Instead, you only trade with a company’s funds.
  2. In hedge funds, you need to have a background in the industry. As mentioned above, you don’t need to have an experience in this to start a prop trader.
  3. With hedge funds, you need to periodically write letters and interact with your investors. This is not the case in prop trading.

What is market making?

Market making is an integral part of the financial market. For one, the American stock market runs effectively because of market makers like Citadel and Virtu Finance. These companies are often seen as wholesalers who execute most trades that are placed in the US.

For example, when you execute a trade in Robinhood or Schwab, these firms direct the orders to market makers who fill them. This process is known as payment for order flow (PFOF). 

Advanced proprietary trading companies have partnerships that reward them for providing liquidity in the market. This happens because these firms have a direct market access (DMA). DMA allows traders to select their preferred gateway or market maker and then they can make some money doing that.

Risk management and capital allocation in prop trading

The most important part for all prop trading firms is risk management. Without managing risk well, these firms will likely go out of business in a few years. At the same time, the companies want to allocate more funds to the most profitable traders.

The first part of risk management is to ensure that they only use qualified traders. As such, they always test them in a certain period. For Real Trading, customers must first open at least 10,000 trades in the demo platform. 

Further, these companies ensure that new traders can only execute smaller trades. Other risk management strategies are that the firms ensure that the trader closes all trades before the market closes.

Other firms limit the amount of leverage that traders use in the market. In most cases, companies allocate more money to their higher-performing traders.

Types of prop trading companies

There are different types of prop trading companies, including the traditional one, prop shops, and remote prop trading firms.

Traditional prop trading firms

These are the oldest types of proprietary trading companies and in some cases, they are the biggest in the industry. These are companies that hire their own traders who are then allocated funds to trade. As such, they have a close resemblance to hedge funds.

In most cases, these companies have their own trading techniques, which gives them an edge in the market. Some of them focus on arbitrage strategies while others have expertise in algorithmic trading. The biggest firms in the industry are Jump Trading, Jane Street, and Lux Trading Firm.

The challenge for using these prop trading companies is that it is almost impossible to get in. They mostly have a long recruitment process and only a small number of applicants get in.

Prop trading shops

The other type of prop trading firm is known as the prop shops. These are companies that require a trader to have some substantial amount of money and then they can provide additional capital.

Remote prop trading firms

These are highly popular prop trading firms that work entirely online. The company has a website where users can sign up and go through tests.

In most cases, the firm will require the trader to make an initial deposit based on the amount of money they want to trade. For example, depositing $200 can give you access to an account with $10,000.

Getting started with these companies is a relatively easy process. You will need to create an account, deposit funds, go through a test, and start trading. Some of the most popular companies are FTMO, The 5%ers, and SurgeTrader.

What is a proprietary trader’s job like?

A prop trader’s job is a relatively simple one. In most cases, these people work from Monday to Friday. A typical day starts with checking the latest market news and the events that happened overnight.

In the next stage, the trader reviews the economic and earnings calendar to prepare for the key events to watch. The economic calendar lists key numbers like jobs, inflation, and manufacturing while the earnings calendar lists companies publishing their earnings.

After that, the trader can review the trading journal and the watchlist. The watchlist is a list of companies that are trending in the pre-market session. Finally, they then start trading and taking breaks along the way.

In the final stage, they ensure that all trades are closed and then they assess their profit and loss for the day. 

Related » How long is a day trader’s business day?

Education and qualifications for prop traders

A good thing about prop trading is that most companies don’t look at education and other qualifications. In most cases, these companies look at the trader’s performance. At Real Trading, most of our successful traders don’t have a finance or business background.

However, some prop trading companies like Two Sigma and IGX require people with a mathematical, statistics, and computer science background.

Prop Traders (and day traders too) need another key stuff: continuous learning. The markets are constantly evolving, and traders need to stay updated on market trends, economic developments, and new trading techniques. The willingness to learn and adapt is a key trait of successful traders.

Benefits of proprietary trading

There are several benefits that come in joining a proprietary trading firm.

Professional Training

First, the company behind the service will offer you adequate training about trading. Indeed, most people who start prop trading usually don’t have any experience about the industry before.

Buying Power

Second, money is a major challenge for most people who are interested in trading. A key benefit with prop trading is that the company will give you the funds you need to trade. You will only be required to pay a small refundable amount for your trading hardware.

Methodology and Mentors

Third, unlike retail trading, prop trading involves following certain easy-to-follow trading methodology. This can help you avoid making mistakes.

Fourth, depending on the prop trading firm that you decide to use, you will always have access to experienced traders who will guide you through the process.This is because it is in the company’s interest to make its traders profitable.

Easily start your business

Finally, with prop trading, it is relatively easy to start your trading floor. This is a very difficult thing to do when you are a retail trader.

Related » Retail Trading vs Proprietary Trading Accounts

Cons of prop trading

While prop trading has its own advantages, it also has some disadvantages. Some of the top cons are:

  • High-pressure environment – Prop trading can be a high-pressure working environment. Some companies mandate their traders to open a certain number of trades per day.
  • Commission-based – As a prop trader, you will make money when you are profitable. As such, you will go for some months without payment when you lose money.
  • Trading limitations – As part of their risk management, some prop trading firms implement some rules that can impact your trades.
  • Account suspension – Breaking some rules can lead to your account being suspended without notice.

Psychological aspects of prop trading

Like in retail trading, day traders have to contend with several psychological aspects when trading in a prop firm. Some of the most popular ones are:

Working in a high-pressure environment

As a retail trader, you make your own rules. You can also decide to avoid trading for several days. This situation is different in prop trading since you are not using your funds to trade.

As such, in most cases, you will trade in a high-pressure environment, especially during times of market turmoil. Traders must develop effective stress-management techniques to stay focused, cope with stress and make rational decisions under pressure.

Managing emotions

Trading can be emotionally intense, especially during volatile market conditions or when facing losses. Traders must learn to manage emotions like fear, greed, and anxiety.

Emotional decision-making can lead to impulsive actions that are detrimental to trading strategies. One example above all is revenge trading. Here, traders make impulsive trades to recover their losses. This often leads to more losses and emotional distress.

There are several ways to deal with these issues like taking a break, always having a stop-loss, and having a mentor.

Maintaining discipline

The other psychological aspect to remember is about discipline. We recommend that you learn and maintain the highest level of discipline as a trader.

Some of the things to do are always keeping time, following your strategy, avoiding fear of missing out (FOMO), and not having a stop-loss and a take-profit.

You also have to deal with many common cognitive biases that can hurt your trading. For example, overconfidence or confirmation bias, but also gambler’s fallacy.

3 Proprietary Trading Strategies You Should Know

#1. Volatility Arbitrage

In proprietary trading, traders who engage in Volatility Arbitrage are guessing on the changes that will happen to the value of an asset rather than what the price will be. When these changes occur, a difference will exist between the option’s guessed price and the asset’s actual market price.

How to Use it in Proprietary Trading?

In prop trading, such options are part of a portfolio that is neutral. Traders who buy these options are known as holding a long-volatility position. Those selling are said to hold a short-volatility position.

A long-volatility position is betting that the asset’s future volatility will be more than when the trade was made. Short-volatility position is betting that the future volatility will be less. These trades feature put call parity. It is not important if the options traded are puts or calls.

But some traders believe that Volatility Arbitrage is risk-free. This is not true!!

These trades rely on guessing.

The way that the asset’s implied volatility will follow in the future. There is always the possibility of a “black swan” event. Or an event that is a complete surprise and affects the value of the option.

This can be true even with portfolio-based approaches that are made to mix risks.

#2. Merger Arbitrage

Risk arbitrage is a hedge-fund which uses the stocks of two companies that are merging (here some tips to trade a Corporate Merger). Stocks in each company are bought and sold at the same time in an effort to guard against risks.

The main risk is that the merger will not close at all or it will be delayed. Traders who are involved with proprietary trading companies use this strategy a lot. This risk means that the target company’s stock sells for less than the stock in the merged company will sell for once the merger closes.

Traders expect that the difference between the two prices will provide them with a profit.

Related » How to maximize returns with a statistical arbitrage strategy

#3. Global Macro

In prop trading, traders use the Global Macro strategy to get results. They analyze information about economic conditions around the world. This way they can make an “educated guess” regarding the effect it will have on prices. Using this requires analyzing many factors in the market:

  • Emerging economies
  • Global trade imbalances
  • The strength of various currencies

Managers working in global macro differ from regular managers since they rely less on general beliefs in the stock positions. There are many prop trading jobs available for you to get started, and salary can range in different countries.

How to Trade the Emerging Markets Profitably

Final thoughts

Proprietary trading is an excellent starting career for anyone interested in finance or in the financial market. When using a good firm, you will have the ability to trade a wide range of assets such as:

  • stocks
  • currencies
  • commodities
  • exchange-traded funds

All this without risking a substantial amount of your money.

In the past, we have seen people who started with nothing and moved on to start trading offices with millions of dollars in profits!

External Useful Resources

  • Day Trading Jobs With Proprietary Trading Firms – TheBalance
  • What is a proprietary trading firm and what is its function? – Quora
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