Prop Trading: An Insider’s Guide
TLDR – What is prop trading, in simple terms?
Prop trading, short for proprietary trading, is when a proprietary trading firm funds a trader with the firm’s own capital instead of client money. The trader keeps an agreed percentage of profits, commonly between 30 and 90 percent. Many prop firms also supply proprietary technology and data feeds that retail traders cannot access on their own.
To see prop trading another way, think about this: Imagine a rich stranger believes in your trading so much, he’ll let you trade his own money. If you make a profit, you keep some of it. If you lose, you don’t owe him anything.
Sound nice? Prop trading might appeal to you.
Sound too good to be true? You may be surprised.
Table of Contents
What is Prop Trading?
Prop trading is when a proprietary trading firm lets you trade their own money. Not client money, the firm’s money. They may also let you use their own private technology and services not available elsewhere.
Some prop firms for beginners focus on training traders, while some prop firms cater to more experienced traders.
Prop Trading is when a firm provides a trader with company capital and technology, in exchange for a share of the trader’s profits. Prop trading is shorthand for Proprietary Trading, which is a much broader industry than just a decade ago.
Key Takeaway
In less technical terms, prop Trading is like having a rich uncle who believes in your trading so much, he’ll let you trade his own money. If you make a profit, you get to keep some of it. If you lose, no hard feelings, you don’t owe him anything.
Prop trading used to be obscure; nobody outside NYC or Chicago knew about it. Anytime told someone what I did, I got a blank look and a dozen questions. #1: “What on earth is Prop Trading?”
#2: “Is that like the movie Boiler Room?” *face-palm*. Nope. How well do you know me?
They just hadn’t heard of it. And they assumed that anyone making money in the stock market had to be cheating in some way.
There weren’t many prop firms, and the ones that existed didn’t advertise. You really had to seek them out. Nobody who wasn’t an avid trader already had even heard of the concept.
A few things have changed since then, mostly in the last 15 years:
- A handful of new prop trading firms, A.K.A. prop firms, started popping up.
- Five years later, “online first” remote trading firms launched and gained traction since they were more accessible.
- In the last 5 years, dozens of online prop firms have launched.
- With the new age of internet advertising, the new firms advertise heavily.
- In the last five years (since 2020), the public has taken more interest. More people explore trading for a living now than at any time I’ve seen. Commission-free trading, market volatility, and all things Covid-19 spurred that on.
Now, everyone and their sister wonders about proprietary trading and whether they could do it. And I think that’s a great thing!
Is prop trading legal in the United States?
Is prop trading legal in the United States?
Prop trading is fully legal in the United States for non-bank proprietary trading firms. The Volcker Rule, enacted after the 2008 financial crisis, banned proprietary trading inside banks, defining it as any transaction where the bank acts as the principal buyer or seller. Independent prop firms operate legally and openly, unaffected by that banking restriction.
In other words, prop trading is as legal as driving 34mph in a 35mph zone with all your tags up to date, headlights on, and both hands on the wheel.
Why does anyone think it’s not legal? I don’t know. Maybe it just seems too good to be true, that a company would give you money to trade with. Sorry to disappoint the haters…it’s legit and 100% legal.
How Do You Become a Prop Trader?
How do you become a funded prop trader?
For most people, becoming a funded prop trader starts with learning to trade profitably, then passing a prop firm evaluation. During the evaluation, you pay a fee, trade a simulated account for a set number of days, reach a profit target, and stay under the maximum loss limit. After signing the funding agreement, the firm activates your funded account.
In that context, the most important step to becoming a prop trader is to actually learn how to trade. I’m not being a smartass, really. Once you know how to trade for consistent profits, getting funded is just another process.
But it wasn’t always that way. Before online prop firms, the only options where the two you see below – Brick & Mortar prop firms and Semi-Prop Firms.
The Online Prop Firm route:
- Learn how to trade and make consistent profits in the market each week, each month, throughout the year. Do it on a simulation account if you need to.
- Sign up for an evaluation with a prop firm. You pay a fee, and they give you a simulated account they can monitor and control. Think of it like a tryout.
- Trade the required number of days, follow the rules, don’t hit your max loss, and reach your profit target.
- Get your paperwork, read it (review with an attorney if you want), sign it, and get set up with your funded prop firm account
- Now you’re a prop trader.
That’s the basic evaluation model used by many futures funding companies. Topstep is one of the best-known examples, but there are better Topstep Trading Combine alternatives with different evaluation structures, costs, trading rules, and paths to a funded account.
The Old-fashioned Way (Brick & Mortar Proprietary Trading Desk)
- Apply for an internship, do the interviews and tests, be an intern for an indefinite period of time, and maybe get to become a trader
- Apply as an experienced trader (usually have to show 3yrs profit history), hope to get an interview and get hired. Start out on a simulation account anyway, most likely, before proving profitability and getting a prop account.
The Semi-Prop Way:
- Deposit your own capital, usually a minimum of $10,000-25,000, in exchange for better leverage than retail gets (15x-30x)
- Read more details about proprietary trading jobs and how to get one
How do prop traders get paid?
Most prop traders get paid through a profit split, keeping roughly 30 to 90 percent of the trading profits they generate, with monthly payouts being the most common schedule – but even daily payout prop firms exist. Salaries are rare, and never at online prop firms. Prop trader compensation runs as a pure meritocracy tied to performance.
Think of it like how salesmen get paid on profit share. When traders make money with their account, they get a percentage of their profits.
Most prop traders don’t go into it for a steady salary. They want to maximize their potential earnings based on performance. That matches up with how most firms compensate traders.
Read more details about trader earnings and day trader salaries.
Consider you aren’t risking your own money, you may find that the potential juice is worth the squeeze.
How Many Hours Do Prop Traders Work?
Becoming a prop trader is like starting a business. A lot of the heavy lifting is front-loaded. Prop traders spend long hours learning and building their skills as a trader. Later on, they might work 5, 9, or 12 hours a day, depending on their strategy and the market environment.
When I first became a prop trader in 2007, I worked 10-12 hours a day. After the first year, I worked a regular 8 hour day, sometimes less, sometimes a little more.
Years later, it was 2020. We all remember how the market changed when COVID-19 started brewing in China. Governments started doing the chicken-little dance. The markets followed their lead.
The increased volatility and round-the-clock movement had me working 3am-7pm CT without more than a bathroom break or two. That was worthwhile for about a year, and then it wasn’t, and I started working regular hours again.
These days, I start pre-market work around 7am CT. I rarely trade in the afternoons and am done trading by 12pm CT at latest. I usually do my post-market work in the evening. Most days that’s 1-2 hours or less, for a total workday of about 6-7 hours.
Bottom line, be prepared to work longer than average hours at first. Once established, your strategy and current market opportunities dictate your schedule. You might have to be flexible and adapt during times of high uncertainty, but those pass.
Which Brokers do Proprietary Trading?
No banks or brokers do proprietary trading anymore. The cowboys of the bank prop trading world had their wild west heyday in the 90’s and early 2000’s. High salaries, outrageous bonuses, and no repercussions led to massive risk-taking. Nobody was thinking about the risks. We all saw how that played out.
Remember 2008? That was kind of ugly for most people, wasn’t it? Well, regulators thought so too, so they passed the Volcker Rule. Just like that, prop trading was no longer legal for banks. Banks are still trading. They still have “Sales and Trading” desks. Mostly the traders on these desks have two roles, barely a fading shadow of the old prop traders:
- Trade customer order flow
- Structured hedging
- Market making
- Trading government securities
- Underwriting and associated trades
The language wasn’t shy about it, the Volcker Rule flat-out bans proprietary trading for banks. It defines proprietary trading as any transaction in which the bank is the principal buyer or seller.
A few things have been edited since then to create little gray areas. But if the banks are exploiting these gray areas, they’re not talking about it.
So, if you’re looking for a proprietary trading job at a brokerage or bank, I’m [not-so-]sorry to say, you’re SOL. Look for non-bank prop trading jobs instead.
What is the difference between prop trading and market making?
The difference between prop trading and market making is the profit source. Market makers earn the bid-ask spread, sometimes fractions of a penny per share, by continuously quoting both sides to supply liquidity.
Prop traders instead profit from directional price moves in a security. One firm can run both a market-making desk and a proprietary trading arm.
With market making, the firm must buy and sell at any price in order to maintain an orderly market. Market makers aren’t taking large positions one way or the other, they’re providing liquidity and hedging their book.
Is Prop Trading Risky
Yes, of course it is. Prop trading is risky in the same way as professional fighting. Every time you step in the octagon, there’s a good chance you’ll get punched in the face a few times. But by training and honing your skills, you can hit back harder and more often than the market hits you, and you can win.You already know trading involves risk. Every trade you risk potential loss for potential reward. That’s pretty simple. Choosing it as a career is a different kind of risk, more like starting a business.
Let’s compare:
| Starting a Business | Both | Prop Trading |
|---|---|---|
| Invest a chunk of your own money | Might not get paid for a while | Some small costs, but no big investment from you |
| Take out loans to fund the rest. | You can fail completely and have to find some other career. | Someone else puts up the money, no loans. |
| At the mercy of customers | Challenging yet rewarding | No customers at all |
| At the mercy of the economy | You must commit at least 2-3 years to it | Endless unknowns in the market |
| Rarely recession-proof | It eventually gets easier, but still a challenge | Recession-proof |
| Employees depend on you | You must take responsibility for your success/failure | No employees, just you |
| Harder to scale up your own income. Economic cycles, overhead | If you fail and have to get a job doing something else, hiring managers might not know how to value your experience. | Easier to scale up your income with very little overhead |
| A successful business doesn’t necessarily mean a successful owner. | The majority fail | A successful trader benefits directly from the fruits of their success |
| No degree required |
As you can see, while you don’t stand to lose a big chunk of your own money, you can lose other things – time being the most valuable.
I’ve started businesses, in addition to trading, and I’ve had some of them fail. I don’t look at that time spent as lost. I gained skills, experience, and relationships. If I failed at trading, I would have gained skills, experience, insight into markets and the world, and so much more.
Prop trading for a living can be risky, but it’s worth it. If you want to know how to mitigate some of the risks, read about proprietary trading jobs
Is Prop Trading Profitable?
Prop Trading is profitable in the same way professional golf is profitable:
- There are a handful of players who make disgusting levels of money.
- There are a whole bunch who made it on the Tour and make a really nice living doing what they love.
- For every one of those, there are ten others who spent years trying and never made anything, never made enough to live on, or lost money overall.
Just as in golf, there are many companies and employees who support the prop trading industry. Software and IT, programmers, and professional service companies all profit from a robust trading space.
Just like great prop traders can make an amazing living, good prop firms can also do well for themselves. The prop firms I know continue to have record years, with most of their revenue coming from trading profits.
Why is Prop Trading Good?
Proprietary trading benefits:
- Traders and the firms they work for
- The market, by adding liquidity
- Investors, by providing liquidity for larger institutions managing investor funds
- Non-trader employees of prop firms
- Companies that provide services to proprietary trading firms
How much can a prop trader realistically make?
A prop trader’s earnings have no fixed ceiling, though even elite solo traders rarely exceed 20 million dollars per year because of liquidity limits and risk management demands. Most skilled prop traders earn far less but still often make more in a single month than the average American earns in a year. Losing stretches remain part of the job.
When a trader gets to that level, or even above $10,000,000 a year:
- It’s a lot of risk to manage, and traders this size often have another person help with managing their trades
- The liquidity needed to trade the size required to make this kind of money, day trading, isn’t always there.
- After several years of earning at this level, they’re more likely to:
- Start their own hedge fund
- Retire and pursue some other long-held dream
- Spend more time investing their money elsewhere
Most traders will never reach that level, but good traders can make a very nice living from trading. They often make more monthly than the average American makes yearly. Keep in mind, they may also have long periods of losing money, even after “arriving” as a trader.
Read more about the earning potential of traders and what it takes to earn various levels of money in a proprietary trading job
Do You Need a Degree to Be a Prop Trader?
Much like starting a business, you don’t need a degree to become a prop trader.
The exception to that would be, if you’re looking to get a trading job with certain firms, or as a trading intern at a brick-and-mortar prop firm.
I’ve traded alongside many traders who didn’t have degrees and still did quite well as prop traders. Some of them did better than me, and I have a degree.
A degree doesn’t usually teach you what you need for trading. The most relevant things it might give you are:
- Methods for doing research, finding information quickly, and analyzing data.
- Math skills, but you rarely need more than arithmetic. Business calculus isn’t something traders use a lot of.
- A taste of what it’s like to study for four years and reach a goal because of it.