Day trading firms offer traders an opportunity to trade with a pool of capital rather than their own money in an arrangement from which all parties benefit.
Many proprietary ("prop") trading firms set up a structure that allows the trader to receive a cut of the profits they generate through trades. This arrangement used by prop trading firms has the potential to be lucrative, but there are steep challenges that can make it difficult to generate those profits.
- Day trading firms allow traders to trade with a pool of capital rather than their own money and receive a cut of the profit.
- These are known as "proprietary trading" or "prop" firms, and working for one can be a lucrative career.
- The pros of being a prop trader include being surrounded by experienced traders and access to more capital.
- The cons of being a prop trader include a high level of competition and the potential for high fees.
Being a Proprietary Day Trader
A prop day trader typically works as a contractor to a prop trading firm rather than as an employee. Prop traders are not usually paid an hourly wage or salary and do not receive benefits such as health care. They are typically only paid when they generate a profit, which can take months.
Prop traders work with stocks—also known as equities—currencies, options contracts, or futures on major global exchanges, with the express purpose of producing a profit through their trades. A prop day trader has no clients except for the company by which they are contracted. They do not engage in phone sales or cold calls with prospective customers. A prop trader is not a stockbroker or financial adviser, and they do not care where a stock will be next week or next year. Their focus is on immediate trading trends.
The types of proprietary day traders vary. Some only trade a few times a day for bigger gains. Other proprietary day traders make hundreds of small trades per day, jumping in and out of the market. Some trade the entire day, while others only trade certain hours of the day.
Proprietary day traders may work out of an office, where they are initially trained, or some firms allow them to work from home. Day traders who are allowed to work from home are typically experienced and have a history of success with the firm, or they are hired as experienced traders with a proven track record.
Pros of Proprietary Trading
There are a number of advantages that come from working for a trading firm:
- Being surrounded by traders who can help you become profitable.
- Access to more trading capital than you would have on your own.
- Reduced commissions compared to what retail day traders face.
- Firm trading costs are frequently lower than costs for those trading on their own.
- Access to training from professional day traders. You may have to pay for training, as this helps the firm eliminate traders who aren't serious.
- No need to worry about the $25,000 minimum account balance for day trading stocks.
If you are new to day trading, then training is important. You want to learn from people who produce successful traders.
Cons of Proprietary Trading
There are downsides to working for a firm, compared with trading on your own:
- Many firms have moved online because it is cheaper than having a brick-and-mortar business. This means you might not be sitting physically among experienced traders when you start out. Chat rooms and Skype are useful tools, but might not be as effective as having other in-person traders to answer your questions.
- With more firms online, competition for seats on a physical trading floor is high.
- Retail technology has diminished the advantage of proprietary trading firms once had. Retail traders now have access to trading platforms and internet speeds that rival most proprietary resources.
- While the commissions charged by a prop firm may still be lower, active retail day traders may be able to negotiate better commission rates with their broker.
- Costs charged to traders by some firms include seat rental fees, software access fees, and/or marked-up commissions. A percentage of the profits may also be taken.
If you are an experienced trader, then training isn't as important. Instead, focus on finding the most competitive structure possible so more of your profits stay in your pocket.
If you are considering quitting your current job to day trade, understand that it may take several months or more to start generating an income. That income can fluctuate with no guarantees of success.
Typical Proprietary Firm Structure
Proprietary trading firms typically have two model types or a slight variation on them:
- The firm takes a cut of your profits, anywhere from 20% to 50%. The trader puts up little or no capital, although paying for training may be required. Firms may also require a deposit to offset any losses a trader incurs. Adequate trading capital is provided by the firm based on experience and skill. With this model, trader profits are the main source of income for the firm. Commissions are typically low, as the firm makes little or nothing off commissions, allowing traders to generate more income. The firm may also charge a seat rental or software fee. This model is popular in Canada and other parts of the world.
- The firm takes little or none of your profits, paying 90% to 100% of your gains. Firms leverage your capital, meaning you typically need to have several thousand dollars or more to get started. You get more capital than you would by trading on your own, but the firm is going to make money off of training fees, higher commissions, seat fees, and software fees. This model is prevalent in the United States.
A trader may also be offered a salary plus possible bonuses, and then trained or hired as an employee. This is more common with financial and commodity companies that also have a trading floor. In this case, you are being hired by a company to work on their trading floor, a division that trades company money. Hours for this job are typically long, from eight to 12 hours per day. Comparatively, prop traders typically work less than eight hours, and traders at home may work for less than three hours.
Frequently Asked Questions (FAQs)
How do you start a proprietary trading firm?
All you need to start a prop trading firm is a significant amount of capital. Prop traders use the firm's capital, and if you're starting the firm, then you'll be the one providing it. Once you have the capital you need, you'll hire traders to deploy that capital in the markets. You will also need to register your business entity under the structure that makes the most sense for your business.
Why are banks banned from proprietary trading?
A U.S. law known as the "Volcker Rule" largely stopped banks from prop trading in the wake of the 2008 financial crisis. The goal was to reduce risky behavior at major financial institutions that consumers depend on. If risky day trading puts a bank at risk of shutting its doors, for instance, then that could create problems for any customers with checking or savings accounts at that bank. By banning prop trading, the government sought to separate investment banks from standard, deposit account banks.