Proprietary trading firms, or prop firms, are banks, brokerage firms, or private companies that use their own money to trade stocks, bonds, options, commodities, or forex rather than using their customers’ funds. Prop firms may be exempt from certain regulations under the Securities and Exchange Act of 1934 as they do not hold customer accounts and use their own capital to trade. There are two types of prop firms: traditional prop firms and forex-only prop firms.
Traditional prop firms allocate their own capital to proprietary traders who specialize in trading certain securities, such as stocks or commodities, and use their own strategies. Each prop trader has specific trading limits and risk exposure set by the prop firm. The prop firm may either restrict its prop traders to only trading the firm’s strategy or allow them to utilize their own strategies, as long as they are approved by the prop firm.
A standard set of operations structures allows partners to place a certain amount of capital in a master trading account. From this account, partners can set up sub-accounts for each prop trader and allocate a specific dollar amount for them to trade with. Most prop firms require traders to maintain a certain amount of risk capital to cover any losses in their daily trading. Based on factors such as trading experience, dollar size, and strategy, the prop firm allocates an amount equal to two to 10 times the risk capital to the trader. If properly structured, the prop firm allows outside prop traders to trade the firm’s capital with minimal downside risk but takes a small percentage of the profits. Prop traders can leverage a larger amount of capital with a small amount of their own capital and receive a larger percentage of realized gains to compensate them for any downside risk.
Forex-only prop firms operate differently. The goal of this type of prop firm is to set up traders for funding through leverage, providing capital to profitable traders. The prop firm charges evaluation fees to participating traders, which can range from $50 to $500 or more depending on the size of capital they wish to trade with. Typically, 85-90% of traders participating in the challenges will fail and the prop firms will retain the evaluation fees to fund successful traders while setting aside a portion of earnings to cover any losses. Once traders have proven their profitability by successfully completing the evaluation period, they become part of the prop firm and get to trade its funds
Here are three top requirements to set up a successful firm
Choosing the right broker or provider
When choosing a forex broker or liquidity provider for your proprietary trading firm, it is important to consider the size and experience of the provider. A provider with at least 10 years of experience can be a good choice as it has likely developed a track record of success.
Aligning yourself with a liquidity provider that is committed to helping your firm grow can be beneficial, as they may be able to offer fast execution with minimal slippage. Additionally, look for liquidity providers that have execution servers located in Equinix data centers. These centers are often hosted by large financial institutions and can provide a level of reliability and security for your firm’s trading.
PropTradeTech works exclusively with Eightcap as its prime liquidity provider. With over 5 global offices and multiple data centers globally, Eightcap can provide the best technology possible for our prop traders and prop firm partners to excess top tier market trading conditions and Metatrader platforms and as such are a provider of choice among some of the world’s biggest prop firms.
Choosing the Right software
When selecting software providers for your proprietary trading firm, it is important to find options that are affordable for start-ups. The right software should include a customer relationship management system (CRM) that allows the prop firm to perform administrative tasks such as setting up workflows, receiving leads, allocating tasks, and managing trade parameters and risk analytics. The software should also enable the prop firm to set up challenges with defined risk parameters that traders must meet in order to progress to the next phase.
Here is an example of how this process might work: a potential trader signs up for a demo challenge and pays the prop firm for the opportunity to participate. After a brief due diligence process, the trader is approved to begin the evaluation phase. In order to move on to the next phase, the trader must meet the conditions set by the prop firm. Once these conditions are met, the participating trader is funded and can begin trading in a live account. The software should also offer risk analytics functions and trade parameters such as maximum drawdowns, profit targets, and daily trade limits to help the prop firm manage risk effectively.
PropTradeTech currently runs a tech stack that allows for the above so that prop firm partners can collect payments, opt up traders to the funded stage, and monitor trader progress in real time. This technology directly fuels the client experience and as such is the part of our offering that PTT has dedicated the most of its development to deliver a top level of service to its traders and partners.
Capital Risk Management
Unfortunately, many proprietary trading firms have closed in recent years due to poor financial management. This often occurs when the prop firm spends all its profits without saving enough money to cover expenses and pay out traders. In order to avoid this pitfall, it is important for prop firms to have a disciplined financial risk management model. This can help prevent overspending and allow the firm to focus on long-term growth.
PropTradeTech has found this area to be the most overlooked of requirements to start a prop firm with many entrants focusing on sales instead of risk, which ultimately leads to many issues down the road.
This is also one of the hardest areas of the business to pick up quickly without experience and therefore the timeliest and most effective way to improve risk management at a prop firm is by hiring an experienced solution provider like PropTradeTech.
With over a decade of collective experience in the forex risk management space, we use a variety of models and technology to measure and effectively manage client risk and trade flow for our partnered forex prop trading firms in order to protect against market volatility and lock in trading revenue.
Whilst some of these requirements may present barriers to entering this new exciting space, PropTradeTech has developed an end-to-end managed solution that can allow new prop firms to start operating in less than 4 weeks! If you have thought about starting your own forex prop firm and would like to take the first steps, feel free to reach out to our team here.