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Proprietary trading, or prop trading, is a type of trading where an independent firm uses its own capital to make trades in financial markets. This prop trading firm beginner’s guide will provide an overview of prop trading, including the benefits and risks, the different types of prop trading firms, the skills and qualifications needed to become a successful prop trader, and much, much, much more.

Whether you’re a beginner or an experienced prop firm trader, this guide will help you understand the world of prop trading and how to get started.

Before we begin, welcome to Trading Strategy Guides, if this is your first time here we want to thank you for checking out our content. Our trading strategy blog articles can help you find anything you need to learn more about trading and trading strategies.

If you are new to trading altogether feel free to check out the best guide to understanding financial markets.

Additionally, you may want to read the ultimate guide to Forex trading for beginners.

Now that we got that out of the way, let’s take a look at what prop firm trading for beginners actually is.

Introduction — What is Prop Trading, What is a Prop Firm, and how are they different from other trading firms?

You are currently reading the first article in our prop account trading series.

In this article, we break down all the components of what it means to be a prop trader, as well as the characteristics of prop trading firms.

In the next article, we teach you how to become a prop trader, teaching you all the basics, and the research required to get started as a prop trader.

The third article attempts to answer the question “Is prop trading legal for US citizens“, this can be confusing for some US citizens based on the some of the rules and regulations of from the SEC and other financial regulation authorities.

Next, we elaborate on the prop firm exam, by teaching you how to pass a prop firm trading test. We give you a simple strategy and try to emphasize discipline and risk management when it comes to take a prop firm trading test.

The final article, will give you some of the best prop firms to trade with. We’ve provided an in-depth breakdown of the top 10 best prop trading firms of 2023. There are a lot of prop firms to choose from, so we decided to make a list to break it down for you.

Now let’s begin learning all about prop firm trading!

What is prop Trading/Firm?

Proprietary trading, also known as prop trading, is a trading career field where a financial institution, or prop firm, hires traders to trade the firm’s funds for a profit.

Prop firms operate as standalone businesses. Their profits and losses are entirely dependent on their trading performance. Traders working within a prop firm are given access to the firm’s capital and are compensated through a profit-sharing agreement based on their trading performance.

Proprietary firms provide traders with the necessary infrastructure, tools, and support to promote successful trading. This includes access to trading platforms, market data, risk management systems, etc.

However, prop trading can be highly competitive and challenging, requiring traders to have a deep understanding of market dynamics, risk management, and trading psychology.

Prop firms also typically have strict risk management policies in place to protect their capital and often use sophisticated trading strategies and algorithms to generate profits. While proprietary firm trading can be a lucrative career for those with the right skills and qualifications, it also comes with risks and challenges.

What is the difference between prop firms and other trading institutions?

Prop firm trading has some major differences from conventional trading firms. Traditional trading firms act as fiduciaries (or financial advisors) on behalf of the client to invest the client’s own funds while charging them a fee regardless of trade performance.

Proprietary trading firms differ from other trading institutions like hedge funds and investment banks in several ways. Firstly, prop firms provide traders with capital to trade, while other institutions require traders to bring their own capital. Secondly, prop firms may offer higher leverage to traders.

Thirdly, prop firms typically focus on short-term trading, while hedge funds and investment banks may have longer-term investment horizons. Fourthly, prop firms pay traders based on their trading performance, whereas other institutions may offer fixed salaries and bonuses.

Fifthly, prop firms may have stricter risk management policies due to the large amounts of capital they are responsible for. Lastly, prop traders typically have more independence in their trading decisions than traders at other institutions, who may have to follow specific investment mandates or strategies.

Prop Firm Trading - Prop Vs Traditional Firm

Types of Prop Trading Firms.

There are several types of prop trading firms, each with its own unique characteristics and strategies. Some firms focus on a specific asset class, such as equities or commodities, while others may specialize in a particular trading strategy, such as high-frequency trading or options trading.

Some firms may also have a global presence, with offices in multiple countries and access to a wide range of markets. It’s important to research and understand the different types of prop trading firms before deciding which one to work with or invest in.

Several of the different types of prop trading firms include:

Independent Proprietary Trading Firms

These are trading firms that use their own capital to make trades in a variety of financial markets. They are independent of any other financial institution.

Investment Banks with Proprietary Trading Desks

These are large financial institutions that have a dedicated team of traders who trade with the bank’s own capital.

Hedge Funds

These are investment firms that use a variety of strategies to generate returns for their investors, including proprietary trading.

Broker-Dealers with Proprietary Trading Desks

These are firms that provide both brokerage and trading services, and have a team of traders who trade with the firm’s own capital.

Market-Making Firms

These firms provide liquidity to financial markets by buying and selling securities and making profits through the bid-ask spread.

High-Frequency Trading Firms – These are firms that use computer algorithms to make trades at high speeds, making profits through small price movements.

Remote Proprietary Trading Firms – These are firms that allow traders to work remotely, and provide access to the firm’s trading platform and capital.

Prop trading exists at hedge funds, asset management firms, commodities companies like Vitol and Glencore, and small/independent trading firms – and it used to exist at large banks before the 2008 financial crisis. In practice, “prop trading” usually refers to the smaller, independent firms that focus on market-making. [1]

How Does Prop Trading Work?

As we touched on earlier, prop trading involves a firm using its own capital to make trades in financial markets. The goal is to generate profits for the firm, which can then be distributed to traders as commissions, bonuses, or used to grow the business.

Prop traders use a variety of strategies to identify profitable trades, including technical analysis, fundamental analysis, and quantitative analysis. They may also use leverage to amplify their returns, which can also increase their risk. Prop trading firms typically have strict risk management policies in place to mitigate these risks.

Skills Required for Prop Trading.

Proprietary trading, or prop trading, is highly competitive. Yes, really! Being successful requires a broad, unique set of skills. Successful traders must have a strong understanding of financial markets, as well as the ability to analyze data and make quick decisions, possibly under pressure.

They must also possess excellent communication and interpersonal skills, as they often work closely with other traders and clients. Additionally, prop traders must be able to manage risk effectively, as trading can be highly volatile and unpredictable.

While many skills can assist traders on their road to success, we want to highlight two, trade psychology and trade management:

Trade Psychology

Trading psychology is arguably the most important skill necessary to become a successful trader. We all know that in trading, you will never see a 100% success rate. You could even have a 90% success rate strategy and still blow your account because of irrational choices made.

It’s easy to get sucked into the profit potential of trading, but without emotional control, you will fail. Ask any professional trader, and they will tell you the same thing.

Further Reading: Trading psychology guide

Trade Management

It’s most important to keep your mental faculties in check while trading, but a close second is trade management. Trade management is all about having a plan for your money, your trade sizes, when to enter, and when to exit. Let’s bring in, for just a minute, Kenny Rogers to explain this concept for us:

You gotta know when to hold 'em
Know when to fold 'em 
Know when to walk away 
And know when to run 
You never count your money 
When you're sittin' at the table 
There'll be time enough for countin' 
When the dealin's done

~ The Gambler [2]

Trade management and trade psychology go hand in hand. You can’t have one without the other. The important thing to remember is to have a plan. . . AND STICK TO IT! I don’t know how many times, traders actually have good plans, with winning strategies, but as soon as something goes wrong or they follow a whim, they lose focus, and the next thing you know, they have blown their account.

Further Reading: Trading Risk Management Strategy

How Do I Get Started in Prop Trading?

Pay a Fee

Depending on the firm, it’s pretty easy to get started. Most likely you are going to be required to put up some capital upfront, and take a test, or series of tests (you didn’t think they would let just anybody trade their money did you?).

The reason behind this is that you are being entrusted with thousands to possibly millions of dollars of the firm’s hard-earned cash. They are not going to let just any average Joe, play with their money. They need to make sure that you can be trusted to trade responsibly, and effectively.

Take a Test

Some prop firms are more selective and will require months or years of trading records that demonstrate you have been trading successfully.

Additionally, you will most likely be required to pass a test or exam of some sort. Depending on the type of firm, it could be timed, require a profit target, or both.

What are the Best Trading Strategies To Be Successful in Prop Trading?

It may sound cliche, but the best strategy is the one that makes you consistent profits. There are thousands of strategies out there, and many of them CAN make you profitable, but having the best strategy isn’t the only important thing to becoming a successful prop trader. You must have discipline, knowledge of the markets, and mental fortitude.

With that being said, the best strategy will also depend on your personality, and the type of trader you want to become. Some people are naturally more inclined to use a day trading strategy, while others prefer longer-term trading or swing trading.

Once you have exposed yourself to the world of trading a little more you will begin to figure out what kind of trader you want to become and what strategy(ies) you want to use.

Further reading: How to pass a prop firm test, List of different trading strategies

What Markets and Instruments Are Traded in Prop Firms?

Proprietary trading firms are very broad, and because of this, you could find a prop firm that trades nearly any market that you’re interested in.

With that being said, in general, when most people think of prop firm trading, they are thinking about Forex. With that being said, many Forex brokers provide a wide range of markets that can be traded as spot Forex instruments. For example, gold (XAUUSD), silver (XAGUSD), oil, (Brent or WTI crude), even Bitcoin (BTCUSD), and many other cryptocurrencies.

Additionally, many stocks and indices can be traded as contracts for difference CFDs[3].

There is no shortage of markets and instruments that can be traded with proprietary trading firms.

How Much Do Prop Firms Pay?

Understanding prop firm pay is usually quite simple. Remember, you are trading with the firm’s money, so they will make sure that you are responsible with their funds before letting you loose. Simply put, if you make money for the firm, you make money, if you lose money, you lose your job.

Independent proprietary firms typically do not pay in the conventional methods, i.e. salary or hourly. Instead, they generally utilize a profit-sharing method of payment. Prop firms are designed to make money through the success of their traders, therefore, payment is typically based on merit.

If you are not profitable in your trading then you won’t get paid, and likely won’t stay with the firm too long. If you are profitable then you will be rewarded with a percentage of the profits that you make.

With all that being said, you can expect prop firms to pay anywhere between 25% to 90% of the profits earned by the proprietary traders. It is a wide range, but it depends on a lot of factors. Most prop firms will have their prices posted on their website.

What Kinds of Rules Do Prop Firms Have?

To protect their assets, and reign in potential rogue traders, prop firms will most likely have a few rules in place that traders must abide by. It may seem unfair, especially if you have a strategy that you know is profitable, but prop firms need to know that their money is safe.

Let’s go over some of the rules that you might see from a prop firm:

Mandatory Stop Loss

I’ve known a lot of traders that just don’t like to use stop losses. If that’s you, then you need to start using them, or likely you won’t find a prop firm that will let you on board.

If you think about it, this rule makes a lot of sense, especially from a prop firm’s perspective. By setting a stop loss you are minimizing the loss that you could potentially take on any single trade.

No Positions Held Through The Weekend

How many times have you been holding a position, and over the weekend some major event happens? You immediately think to yourself “I gotta close that trade!”.

It’s just another avenue of protection for firms, if the instrument you are holding decides to gap up or down in a huge way against you over the weekend, then you’re stop loss can’t save you.

Max Drawdown

A lot of firms will have a max drawdown of some sort. Meaning that there is a max percentage of the account that you can lose in any given period. Usually, it’s a percentage of the account, i.e. 5% or maybe even as high as 10%.

In most cases, they’ll likely have two versions, a daily max drawdown, and an overall max drawdown. Again, this is just to protect their accounts and to hold traders accountable for their trade performance.

Hard Vs. Soft Breaches

In prop firm trading breaking certain rules over others can be considered more egregious. For example, not setting a stop loss, may result in the trade being closed automatically indicating a soft breach. But, if you break one of the drawdown rules that would result in your account being closed, a hard breach.

This is not an exhaustive list, so make sure you check the rules with the firms that you are interested in before signing up. As you can see not all rules carry the same weight, therefore when trading for a prop firm you need to be aware of the specific rules of the prop firm that you are considering joining.

What kind of training and support do prop firms provide to traders?

This can vary greatly. Some prop firms only want the best traders, so their education is limited because they already expect you to know how the market works. Others might have a course that you can take (either free or paid) before or during your prop exam.

You can always check out the Trading Strategy Guides blog to get a wealth of information that can help you in your prop trading journey.

What Trading Platforms Can You Use With Prop Firms?

Proprietary trading firms will often provide their specialized trading software that traders must use. These platforms are tailored to the firm’s specific trading strategies and may offer unique features not found on other platforms.

On the other hand, some firms may allow the use of third-party platforms, such as MetaTrader 4 or TradingView, this is dependent on the firm’s policies. Traders must be familiar with the platform they will be using before starting at a prop firm, as it can greatly impact their trading performance.

Additionally, traders may need to undergo training or testing to ensure they are proficient with the platform before trading live.

What Are Some Of The Different Career Paths For Prop Traders?

Hedge Fund Manager:

Many successful prop traders move on to become hedge fund managers. This allows them to manage money on a larger scale and earn a percentage of the profits.

Quantitative Analyst:

Some prop traders have a strong background in mathematics and may become quantitative analysts. These professionals use mathematical models to analyze financial data and develop trading strategies.

Investment Banker:

Prop traders who have strong analytical skills may also choose to become investment bankers. These professionals help companies raise capital by underwriting securities, conducting research, and providing financial advice.

Portfolio Manager:

Prop traders who have a strong track record of successful trading may become portfolio managers. In this role, they are responsible for managing a portfolio of assets and making investment decisions.

Risk Manager:

Some prop traders may choose to become risk managers. In this role, they are responsible for identifying and managing the risks associated with trading activities.

Financial Advisor:

Prop traders who have a strong understanding of the financial markets may become financial advisors. These professionals provide advice to individuals and businesses on how to invest their money.

Entrepreneur:

Some prop traders may choose to start trading firms or other financial businesses. This allows them to be their boss and pursue their trading strategies.

Pros and Cons of Prop Trading.

Pros

Prop trading offers a range of benefits for traders looking for a career that maximizes their earning potential and improves their skills.

Access to Capital

One of the key advantages of prop trading is access to significant amounts of capital, which can be used to increase profits and reduce personal risk.

Risk Management Systems

Prop firms also typically have risk management systems in place to help minimize losses, as well as training and mentorship programs to support traders in improving their skills.

Tools and Technology

Additionally, prop trading firms often have access to advanced technology and tools, which can help traders execute trades more efficiently and effectively.

Merit-Based Compensation

Performance-based compensation is another potential benefit, incentivizing traders to perform at their best and aligning their interests with the firm.

Flexibility

Another big bonus for prop trading is that it also offers a high degree of flexibility and autonomy. Traders can work from anywhere and pick their timing as long as they manage their trading strategies and positions.

While prop trading can be highly lucrative, it is also a high-risk field that requires effective risk management and a competitive mindset. Despite these challenges, many traders find prop trading to be a rewarding and exciting career path.

Cons

Prop trading has drawbacks that traders should consider before entering the field.

High barrier to entry

One of the biggest cons is the risk of losing initial capital, as traders typically must use their own money to get started with the firm.

Performance Targets

Prop trading firms have high expectations and specific performance targets, which can create pressure and limit a trader’s flexibility. Sharing profits with the firm can also significantly reduce earnings, and there is no job security.

No hand holding

Competition is high, and training and support may be limited. Prop trading firms may not have access to the same resources as larger financial institutions, like hedge funds or banks.

This fact could contribute to a lack of transparency about standards, operations, and performance.

No benefits

Finally, unlike traditional jobs, prop trading firms typically do not offer benefits such as health insurance or retirement plans.

Conclusion – What is Prop Trading

We hope you enjoyed this comprehensive beginner’s guide to better understanding prop trading. We covered a ton of information to better inform you alongside your search to become a proprietary trader.

We talked about what prop trading and prop firms are, how prop trading works, different types of firms, as well as potential career paths, and some of the necessary skills needed to succeed in prop trading, especially psychology and trade management.

We also talked about how you can get started with a prop firm, the instruments you can trade, financial expectations, prop firm rules, and the pros and cons of being a prop trader.

Please feel free to comment below on our Prop Firm Trading Guide. Let us know if we missed anything or if you would like to discuss some of the concepts that we talked about today.

Up Next:

Read How To Be A Prop Trader

If you need more guidance on where to go from here, see the below list of some “required” reading to help you on your path to becoming a successful prop trader.