Let us imagine that a financial company or a commercial bank is faced with a choice: what will be the source of the company’s profit? Will it be the profit from commissions from clients’ trading or from trading on its own funds? If the first option is a low-margin way of earning, then the second can bring a much higher yield.
Proprietary trading companies believe that they have a competitive advantage or understanding of some market inefficiency that will allow them to earn an annual income that exceeds the index (positive alpha).
Proprietary, private, proprietary trading, proprietary trading is precisely the case where a financial company prefers to generate profits directly from market activity rather than from commissions with minimal margin derived from client trading. Such a company is focused on proprietary trading, where it takes all profits from trades, not just commissions.
A proprietary trading company, unlike a fund (a hedge fund or an investment company), operates with its own capital or the capital of a relatively small number of participants and not invest in a limited number of securities or other financial instruments with subsequent payment of interests/dividends to its investors but uses its own (or attracted) capital to give it to the most successful traders of the company for management, serving for them on the one hand as an investor and increasing their profit.
At the same time, the degree of freedom of the trader who receives the company’s money for asset management is quite high. The main requirement to the trader is to be a profitable, earning trader and to follow the rules of risk management, individual and prescribed by the company.
For the opportunities provided (mainly they concern capital and technical means, such as analytical platforms and trading terminals) trader shares the predetermined part of the profits with the proprietary company.
The classic proprietary trading business consists of the fact that the trader trades entirely on the company’s funds and gives it a percentage of his earnings.
This percentage can be a public offer or an individual agreement with the company. There are also other, mixed forms of proprietary trading. In particular, it is when the trader trades on the company’s capital, but financial risks from trading operations remain on him, i.e. when trading on the exchange, he has access to much more capital, than he has himself, but all losses are covered by his own deposit, which is kept on the company’s account.
In this form of business, a proprietary trading company often acts as a broker – it sets the amount of commission, provides technical support, and gives some leverage, which puts this type of trading in the category of margin trading, i.e. trading with leverage. In addition to the commission, there may be other fees (for example, membership fee) or a percentage of the trader’s profit. In this case, the company receives the trader’s capital in the amount of his deposit for providing leverage to other participants.
How is a proprietary company structured?
As a rule, trading on equity requires a company to have substantial funds in its account, in addition to that it needs access to professional software, computing power to provide internal infrastructure, research department, risk management, department of advertising and attraction/training of traders.
The structure of a prop company looks approximately as follows:
- Prop traders – traders who directly carry out trading operations on the stock market. Usually the company teaches them its strategies, but some traders come with their own. Prop-trader trades on the company’s funds and gets % from the profits of the deals;
- Analysts – they monitor the market and provide traders with company analyses and general market information;
- Risk manager (one or more) monitors the compliance with the risks of pro-traders;
- A manager or head trader – a trader with high skills to make money on the stock market, determines trading strategies, conducts or oversees training.
Prop trading strategies and training
A prop trader can trade the company’s strategy or his own. Since one of the conditions for the existence of prop is the focus on a certain inefficiency, it is logical that the props prefer traders who trade their strategies.
For this purpose, traders are trained and tested (for example, on a demo account) prior to issuing them capital for management. If the trader still wants to trade their strategy, they need to coordinate it with the companies and convince the lead trader that it works.
Prop companies can trade many different strategies and combinations of strategies.
Here are the most common ones:
- merger arbitrage;
- index arbitrage;;
- volatility arbitrage;;
- statistical arbitrage;
- financial analysis of a company’s condition;
- technical analysis;
- global macro trading.
Why do traders need prop trading?
Prop trading creates a number of mutual benefits for traders and prop companies.
For the prop company:
- Higher returns than from commissions on trades and trades on clients’ funds.
- Higher trading volumes.
- Opportunity to become a market maker and create liquidity in some stocks, earning on it.
For the prop trader:
- Capital for trading. If usual brokerage companies give 1:4 leverage, in a prop you can get leverage up to 1:30, significantly increasing your BP (buying power).
- Learning from experienced traders. Practice shows that learning from a professional in his business gives much more effective, than, for example, self-training.
- Working in a team adds discipline, motivates, and speeds up the development of the trader.
How to get into prop?
- An experienced trader with a track record. Experience implies the presence of the Statment/track record – statistics of trading on a real account. If the trader possesses such statistics and is willing to work in an open account, all he has to do is to send this data to the company. After analyzing the track record and communication with the trader, the pro company will decide on further cooperation with him. To find out how to get into the Fondexx promo account, click here.
- Combine. Major prop companies automate and make the universal process of selecting traders. The company initially establishes a set of conditions with the target profit and risk limits. For example, 4 trading weeks are allocated to achieve this result. The trading is carried out on the special real-time demo account, as much as possible corresponding to the real market. If the conditions are fulfilled, the trader gets the account to manage. Participation in the harvester is paid and the cost depends on the account size.
- Contests of traders. Some companies hold prop contests and give accounts under management to the winners. For example, Fondexx Prop Contest is held once a year. At stake are 10 accounts under management and a cash bonus of several thousand dollars, which is distributed among the five winners and is available for withdrawal without any additional conditions.