What is a Prop Shop?
It pays to know the difference between a brokerage and a prop shop
Almost everyone who is involved in the stock market knows what a broker (or broker-dealer) is, how to sign up with one, and what their function is. But you might not know what a "prop-shop" is or what differentiates them from a traditional broker.
The term "prop-shop" is short for a proprietary shop. A prop shop is usually at a physical location where a large number of traders participate in the market using co-mingled money.
What that means is that you combine your money, or your stake, with that of all the other traders who are using the prop-shop's facilities. Funds belonging to the prop-shop itself are also added to the mix.
The advantage of this set up is that as a trader you then have the ability to use the firm's buying power for your trades. This allows you to avoid having the minimum SEC requirement of $25,000 in your account in order to day trade and gives you access up to 10:1 leverage on your stock and options trades.
For example, you could join a prop-shop with a minimum funding requirement of five thousand dollars. Once you deposit your funds you would then have the ability to day trade with no pattern day trading restrictions as well as have access up to fifty-thousand dollars worth of leverage for your trades.
Another aspect of a prop-shop is that they will usually have state of the art equipment and order entry platforms for traders to use.
They will also generally offer education about the stock market and how to trade it. Of course, nothing in life is free and the benefits you get from a prop-shop can come with a steep price attached to them.
Prop-shops make their money in a number of ways, one of which is from margin balances and order flow.
But they also make revenue from the ticket charges incurred by traders using their services. Sometimes the ticket charges cover the expense of a trading station and software but those can also be charged a la carte depending on the firm.
The danger is that if you are doing a large number of transactions each day on top of having to pay "rent" for your trade station and software, it can quickly eat into your account's P&L.
One of the key factors to consider when thinking about using a prop-firm is what type of educational resources they provide. Many less than reputable shops don't care about customer longevity and just try to encourage traders to make as many transactions as possible -- in order to generate the highest amount of ticket charges.
In shops like this, there is a very high attrition rate as traders who are over-leveraged and inexperienced end up eventually blowing their accounts out.
In a reputable prop-shop, there is an emphasis on continuing education for traders. The goal is to create a customer who is self-sustainable and can grow his account value over time, instead of just churning them for commissions. This education can even extend to one-on-one mentoring sessions where you can benefit from the knowledge of an experienced trader.
Though not for everyone, a prop-shop can be a viable option for those who are more active traders in the stock market.
Photo Credit: Steven Puetzer/Photographer's Choice/Getty Images