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What is proprietary trading and how does it work?

Education /
Milan Cutkovic

What is prop trading?

Proprietary trading, commonly referred to as prop trading, describes the practice where traders engage in trading activities using the capital of a prop firm or financial institution rather than their own capital. These traders participate in a range of financial markets and use a variety of financial instruments, including shares, options, futures, and contracts for difference (CFDs). The primary goal of prop trading is to generate profits for the institution using the capital allocated by the firm for trading.

While there are businesses that only engage in prop trading, it is also a practice by:

  1. Investment banks that have desks specialising in proprietary trading. Banks benefit from having extremely valuable information and order flow visibility. However, prop trading within the banks has become heavily regulated since the financial crisis of 2008.
  2. Hedge funds that trade their own funds as well as managing funds for their investors.
  3. High-frequency trading firms that also act as market makers.
  4. Commodity trading firms, such as Glencore, Vitol, and Trafigura, that trade commodities on the physical and futures markets.

 

What is a prop trading firm?

A prop trading firm is a company that provides its traders with access to capital. In return, the traders share a percentage of the profits they generate with the company.

Individuals face many hurdles on their journey to become professional traders. While a lack of sufficient capital is the most obvious one, they may also lack access to technology, market data, and tools. Prop firms can help skilled individuals propel their trading careers by providing capital, training, and general support.

The set-up of prop firms varies significantly. Some prop trading companies have physical offices and will provide a desk for their traders. Others operate remotely and can accept traders across the globe into their programme.

 

What is a prop trader?

An individual who trades using the firm's own funds instead of client funds is known as a prop trader. To make money for the company, they typically participate in speculative trading, which can involve both short- and long-term trading.

Proprietary trading firms typically allow their traders autonomy in making trading decisions. However, they establish a limit known as the maximum drawdown level. If a trader's losses reach this predefined threshold, the firm will intervene and suspend the trader's trading activities to mitigate further financial risks.

Prop traders make all or most of their income from splitting profits they generate in financial markets with the prop firm that provides them with capital.

Prop traders face the same challenges as other traders but benefit from access to capital, technology, and interaction with other skilled traders.

 

How does prop trading work?

When a trader is accepted by a proprietary trading firm, they are allocated a certain amount of capital to trade with. The size of this capital allocation, as well as the proportion of profits the trader is entitled to keep, varies depending on the trader's level of experience and their track record of past trading results.

Prop traders employ a variety of trading strategies, from short-term trading to swing and position trading. Similarly, traders may use either fundamental or technical analysis when analysing markets, or a combination of the two.

While risk management remains critical, trading on behalf of a prop firm is subject to more stringent regulations and increased scrutiny in order to limit the firm's capital exposure to potential losses.

 

How do prop firms work?

To explain how prop firms work, we will use a hedge fund analogy.

Hedge funds have clients who provide the company with capital. The fund managers ultimately answer to their clients, who receive an average of 60–80% of the profit generated.

Prop firms, on the other hand, don´t take on clients as investors but use their own capital to generate profits in financial markets. This allows them greater freedom, flexibility, and the chance to keep a larger percentage of the profits.

 

How do prop firms make money?

Most revenues generated by a prop firm come from the profits generated by the prop traders. Firms have a profit-sharing arrangement in place with their traders. For example, a trader that generates $100,000 in profits during a certain period and has a 40/60 profit share agreement will receive $40,000, while the remaining $60,000 goes to the firm.

Some prop firms, particularly the smaller ones, may earn revenue by providing education, granting access to their capital allocation programme, or utilising their office space and/or technology. However, this is usually only a minor fraction of the revenue generated.

Other firms will charge a subscription or membership fee. Traders might have to complete a challenge before they can officially join the programme and receive funding, and some companies may charge them for this opportunity.

However, this model is in the process of being phased out amid an intense crackdown by regulators and technology providers.

 

Advantages of prop trading

Prop trading can provide individual traders with several advantages:

  1. Potentially maximising their profits: talented traders may lack the funds to scale up their operations. To illustrate, it will be difficult for a trader to generate a significant return on a $200 account, particularly if they refrain from undertaking excessive risks. Property firms may offer these exceptionally skilled traders the chance to establish themselves as professional traders and potentially generate substantial profits.
  2. Autonomy: Although each prop firm will put in place its own risk management guidelines to guard against uncontrollably large losses, traders typically have a great deal of latitude and discretion in how they use the money that has been allocated to them.
  3. Learning curve: Working with other talented traders and seasoned professionals can provide traders with an incredible learning opportunity and the chance to build meaningful connections.
  4. Technology: Access to technology can be costly, with expenses for data feeds, professional charting software, live news feeds, and expert insights adding up quickly. High-end tools, such as Bloomberg terminals, are also significant investments. Proprietary trading firms provide their traders with all these technological resources, enabling them to make better-informed decisions without the individual cost burden.
  5. Potentially lower their risk: The trader assumes reduced financial risk due to the provision of capital by the prop firm.

 

Disadvantages of prop trading

While we have emphasised several significant benefits of prop trading, it is not without its drawbacks:

  1. Increased pressure: If you are purely trading your own funds, you ultimately do not report to anyone. However, trading with the capital of a prop firm comes with responsibility, and the firm will expect the traders to hit their targets.
  2. Lack of stability: Prop firms typically don´t have a lot of patience with underperformers, and they are easily removed from the capital allocation programme.
  3. Upfront fees: Some programmes demand traders to pay a membership or joining fee as well as pass so-called "challenges" in order to participate. This can be a financial burden for traders as well as an unpleasant experience. These business tactics are currently scrutinised by regulators and technology providers as they can be used to manipulate traders in false promises of future profits. Traders pay a registration fee and then must jump through multiple hoops to qualify for funding. In most cases, they never qualify.

 

How to get started with prop trading

The entry requirements to join a prop firm can vary significantly. For example, a prop firm whose traders are based in their physical offices, equipped with advanced software and hardware, and where a lot of effort is spent on supporting and training them will have strict requirements, a long screening process, and a limited number of open positions.

Prop businesses that operate remotely and merely provide traders with a funded account, on the other hand, make it easier for talented traders to join. A trader would typically pay a joining or subscription fee before participating in a challenge or assessment period. They would have to demonstrate their trading abilities with a particular amount of capital, with the prop firm imposing a maximum drawdown and profit target. If the trader successfully completes the challenge, they will be entitled to join the programme and receive extra financing in the future.

With recent regulatory changes, the subscription fee-based model is coming to an end, and many traders choose programmes that use live trading accounts and do not charge traders any upfront costs.

Introducing Axi Select

Axi Select is a capital allocation programme designed to offer a genuine and transparent trading experience with live trading accounts and the absence of any upfront fees*.

Live trading accounts allow traders to operate in a real trading environment that can be subject to slippage or execution. It might not be pleasant for traders, but it’s the real-life conditions that can help traders understand how markets work and how they can protect themselves from losses. Furthermore, traders learn how to manage emotions, such as fear and greed, which is a difficult skill to master when there is no real money at stake. They might also feel the urge to take larger risks in a risk-free environment, which in the long term is counterproductive. Overall, Axi’s live trading accounts help ensure a transparent and structured trading experience.

Axi Select’s structured trading programme provides each participant with an Edge score. This is a score that helps traders track their progress and progresses them to the next stage of the programme, unlocking additional funding. The Edge score is calculated based on the following:

  • Skill: Your ability to generate profits while managing drawdowns.
  • Risk: Your risk management skills.
  • Consistency: Your ability to consistently generate profits.
  • Experience: Whether you meet the minimum criteria for displaying credible trading experience.

As a trader, you need a broker you can trust. Programmes such as Axi Select, which are based on live trading accounts, make money from sharing the profits generated by their participants. Due to the absence of subscription or joining fees*, traders are encouraged to work on their trading skills and succeed. Unlike brokers who profit on registration fees, we are therefore unlikely to remove members aggressively from the programme.

Trading can be a stressful activity and the last thing traders need is to worry about the safety or durability of the capital allocation programme they have joined. Choosing a reputable and trusted operator is crucial so that, as a trader, you can fully focus on getting the results needed to advance your trading career.

Ultimately, becoming a successful trader is not something that can be done overnight, and traders are increasingly turning to programmes that are invested in their long-term success.

How is Axi Select different from other funded programmes?

Programme

Axi Select

Industry Standard

Registration Fee No Yes
Pass Evaluation No Yes
Restrictive Trading Conditions No Varies
Number of Attempts 3 1
Leverage 100:1 Varies, majority less than 100:1
Account Type Real Trading Account Demo
Additional Tools Dashboard/Leaderboard,
Edge Score, Trading Room
Varies

 

 

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* Other fees and minimum deposit apply

This information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. It has been prepared without taking your objectives, financial situation, or needs into account. Any references to past performance and forecasts are not reliable indicators of future results. Axi makes no representation and assumes no liability regarding the accuracy and completeness of the content in this publication. Readers should seek their own advice.

FAQ


What is prop trading?

Prop trading is the practice where traders engage in trading activities using the capital of a prop firm or financial institution rather than their own capital.


What is a prop trading firm?

Prop trading firms are made up of traders who trade with the company's capital. The traders could be full-time employees or only participants in the company's allocation programme.


What is a capital allocation programme?

A capital allocation programme refers to the process of distributing financial resources among different trading strategies or traders based on their performance, risk profile, and potential return on investment.


Why do prop firms provide traders with funding?

Prop firms fund traders to earn a share of their profits, which constitutes a major part of their revenue, and may also gain income through subscription, joining fees, and selling educational courses.


What is the upside for traders joining a prop trading firm?

Joining a prop trading firm offers traders access to more capital, advanced trading tools, and opportunities to network with professional traders.


Is prop trading risky?

Prop trading involves inherent risks like any trading, yet the firm often bears the bulk of it by risking its capital, though traders risk losing subscription or joining fees and not passing the firm's trading challenge. 


Do I need to be an experienced trader to join?

Joining a capital allocation programme does not always require extensive experience, as each programme has its own specific set of requirements.


Can I join a capital allocation programme for free?

Yes! Axi Select was created to give talented traders the opportunity to receive funding without paying any subscription or joining fees.


What is the main advantage of Axi Select?

Axi Select is free to join with no subscription or registration fees*, and traders can keep up to 90% of the profits generated. As the programme is based on a live trading account, it gives traders a realistic and transparent experience.


How does Axi Select help traders to grow?

Axi Select provides clients with a structured journey to potential success through six progressive stages. Its sophisticated dashboard gives you all the insights you need to build your professional trading skills with confidence. Other features include an exclusive online trading room, live analysis, and free educational materials.



Milan Cutkovic

Milan Cutkovic

Milan Cutkovic has over eight years of experience in trading and market analysis across forex, indices, commodities, and stocks. He was one of the first traders accepted into the Axi Select programme which identifies highly talented traders and assists them with professional development.

As well as being a trader, Milan writes daily analysis for the Axi community, using his extensive knowledge of financial markets to provide unique insights and commentary. He is passionate about helping others become more successful in their trading and shares his skills by contributing to comprehensive trading eBooks and regularly publishing educational articles on the Axi blog, His work is frequently quoted in leading international newspapers and media portals.

Milan is frequently quoted and mentioned in many financial publications, including Yahoo Finance, Business Insider, Barrons, CNN, Reuters, New York Post, and MarketWatch.

Find him on: LinkedIn


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