What is proprietary trading?
by Shaun Overton
For traders who have a real talent for forex, yet very little capital of their own, prop trading may be the pathway to a good career or supplemental income.
What is proprietary trading?
To avoid confusion, it’s important to understand that the same term is also used in a different context to refer to the basic concept of any brokerage firm or financial institution that trades in-house for its own account, in addition to processing trades for outside clients of the institution.
In effect, that firm seeks to profit from successful trades rather than commissions from clients’ trades.
Yet, independent traders generally use the term proprietary trading to describe a relationship by which they trade funds for a smaller, more speculative investment firm. In short, the traders use the firm’s money to apply their own strategies, and if successful the firm shares the rewards with the trader.
A “prop shop” is a proprietary trading arrangement with a group of individuals who trade electronically, either at the firm’s facility or in independent trading offices using the firm’s resources. Prop shops provide their traders with the resources necessary for success, including education, capital and trading platforms.
Prop shops have their historical foundations in banks’ proprietary trading. Traditionally, banks and brokerages would make a market in securities and derivatives in which they held positions, in order to facilitate liquidity in the marketplace.
Over time, financial institutions’ in-house traders developed their own proprietary strategies and systems, hence the name.
How prop trading normally works
There are a wide variety of prop trading programs offered by various funds and financial firms. Most do not require the trader to invest money, although some offer prop-trading courses or other educational purchases as part of a package.
All prop shops use performance metrics to monitor trading results and apportion compensation. Traders who have winning forex systems are usually allocated trading capital beginning at $100,000 and well-proven traders often trade far larger proprietary accounts.
Prop trading scenarios require the applicant trader to show early promise of successful trading ability. Some proprietary trading companies use a “farm team” approach by requiring applicants to trade demo accounts online and then selecting the best candidate traders.
Others accept applicants into their trader-education programs which ultimately lead to proprietary trading accounts for the traders who excel during the training phase.
For beginners who show potential, the prop shop usually offers plenty of mentoring and education, as well as technical and psychological support.
In a prop shop, it’s up to each trader to prove his or her ability to consistently squeeze gains out of forex markets. Over time, the successful trader receives progressively larger allocations of capital. So, the trader’s potential income likewise grows.