What Is Prop Trading – A Beginner’s Guide to Proprietary Trading

Introduction: What Is Prop Trading?

Prop trading, short for proprietary trading, occurs when a financial firm uses its own money to trade in the market instead of using clients’ funds. Instead of making money by charging fees or commissions to customers, these firms aim to make direct profits from their trading activities.

For traders, working with a prop firm offers a chance to use larger amounts of money, advanced trading technology, and professional tools that they might not have access to with their personal accounts. In return, the firm retains a share of the earnings, while the trader keeps the remainder.

Example: For example, if you have a $100,000 account and make a $10,000 profit in a month with an 80/20 profit-sharing agreement, you keep $8,000 and the firm takes $2,000.

Unlike regular investing or trading with personal funds, this trading model requires you to undergo strict evaluations to demonstrate your ability to manage risks effectively. This approach has gained popularity in recent years, particularly with the rise of online trading firms that enable participants from anywhere in the world.

How Does Prop Trading Work?

This trading model provides individual traders access to a firm’s resources while enforcing strict rules and risk management. The main goal is to make profits for both the trader and the firm. Here’s how it typically works:

1. Evaluation or Challenge Phase: Most online prop firms require traders to pass an evaluation test before they receive funding. This usually involves:

• Reaching a profit target (for example, 8–10%).

• Staying within a set limit for maximum losses.

• Following daily loss and risk management rules.

2. Getting Funded: Once you pass the evaluation, you receive a funded account, which can range from $25,000 to $200,000 or more.

3. Trading the Firm’s Capital: You will trade in markets such as forex, stocks, cryptocurrencies, indices, or commodities. You must follow the firm’s guidelines regarding how much to trade and how much risk to take on.

4. Profit Sharing: You keep a percentage of the profits, which is often between 70% and 90%, while the firm takes the rest.

5. Scaling Up: Many firms reward traders who consistently make profits by increasing the amount of capital they can trade over time.

Example: If you start with a $50,000 funded account and make a profit of $5,000 in a month, you would keep $4,000 if the profit-sharing agreement is 80% for you and 20% for the firm.

This system benefits both parties: traders can access significant funds without risking their personal money beyond the evaluation fee, and firms earn returns by supporting skilled traders.

Types of Prop Trading Firms

Not all trading firms operate in the same manner. Different types of prop trading firms exist based on their structure and business model:

1. Traditional In-House Prop Firms: These are long-standing firms usually located in major financial cities like New York, London, or Chicago. Traders work in the office, using the firm’s resources, and often focus on fast-moving markets like futures, options, or stocks. These firms typically hire experienced traders and may offer salaries plus bonuses based on performance.

2. Online Funded Account Providers: This is the most common model today, allowing traders to join from anywhere in the world. Traders pay a fee to take an evaluation test, and if they succeed, they receive a funded account. This model has opened up prop trading to a much larger audience.

3. Remote Prop Desks: Similar to funded account providers, but with more focus on teamwork. Traders connect through online platforms, share ideas, and sometimes receive mentorship. These firms often provide community features, educational programs, and opportunities to grow.

4. Hybrid Firms: Some firms combine elements of traditional prop trading with online funding models. For instance, they may have a team working in an office while also offering remote funded accounts for traders globally.

Tip for beginners: If you’re just starting, remote online prop firms are often the easiest option. They allow you to trade global markets using the firm’s money after proving your skills, without needing to move or invest a lot of your own money.

Why Trade With a Prop Firm? (Advantages)

This trading style has gained traction because it offers advantages that personal trading accounts may not provide. Here are the main reasons why traders choose prop firms:

1. Access to Larger Capital: Instead of being limited to your own savings, prop firms can offer accounts from $25,000 to over $1,000,000, depending on your performance. This gives you more buying power and the potential for larger profits.

2. Reduced Personal Risk: You are not risking your own money beyond the evaluation fee. The firm covers the losses as long as you follow their rules.

3. Profit Sharing: Most of these firms offer favorable profit splits, often 70/30, 80/20, or 90/10 in favor of the trader. This means you keep most of your earnings.

4. Professional Tools and Platforms: Prop traders usually have access to advanced trading platforms, data feeds, and research tools that can be expensive for individual traders to buy.

5. Training and Mentorship: Some firms offer coaching, strategy reviews, or mentorship from experienced professionals, which can be very helpful for beginners looking to improve quickly.

6. Scaling Opportunities: Firms often increase your account size as you show consistent profits. For example, a $50,000 funded account might grow to $200,000 after you meet certain performance goals.

7. Community and Networking: Remote prop trading firms often have communities where participants can exchange ideas, strategies, and experiences with others from around the world.

Example: A beginner trader who saves $2,000 to trade on their own can instead use that money to pay for evaluation fees, pass the challenge, and trade with a $100,000 account something they couldn’t do with personal funds alone.

Risks of Prop Trading

While prop trading offers exciting opportunities, it also comes with real risks that every beginner should be aware of:

1. Evaluation Challenges Are Tough: Most prop firms require individuals to pass strict tests before they get funded. Meeting profit targets while staying within daily loss limits can be challenging, and many traders fail several times before succeeding.

2. Strict Rules and Termination Risk: Even after receiving funding, breaking a firm’s rules like exceeding daily loss limits, using excessive leverage, or holding positions overnight (if not permitted) can result in losing your account.

3. Profit Splits: While profit-sharing is generous, you will never keep all your profits. For example, if you make $10,000 in a month, you may only keep $7,000 to $9,000 depending on the profit split.

4. Psychological Pressure: Trading with the firm’s money can increase stress. Knowing that a single mistake could cost you your funded account can lead to emotional decision-making.

5. Risk of Scams and Unregulated Firms: Not all prop firms are reliable or trustworthy. Some operate without proper oversight, making unrealistic promises or establishing unfair rules that can lead to failures. Always research and choose reputable, regulated firms.

6. Limited Freedom: Prop traders must adhere to the firm’s rules about position sizes, leverage, trading hours, and even which assets they can trade. This lack of flexibility can feel restrictive for some.

Important: Just like with personal trading, only risk money (including evaluation fees) that you can afford to lose. Treat prop trading as a professional commitment, not a quick way to make money.

Who Becomes a Prop Trader?

Prop trading attracts various participants, including beginners and experienced professionals. Here are the main groups you’ll find:

1. Retail Traders Seeking Growth: Many retail traders turn to prop firms when their personal funds are too small to generate significant profits. Prop accounts provide leverage and scale without risking large amounts of personal savings.

2. Experienced Day Traders: Traders with a proven track record often join prop firms to access larger accounts, lower commissions, and advanced platforms. For them, prop firms are a way to maximize their trading advantages.

3. Former Institutional Traders: Ex-bankers, hedge fund traders, and floor traders sometimes move to prop firms after leaving traditional finance. They bring professional expertise but prefer the independence and profit-sharing structure of prop trading.

4. Beginners With Discipline: Some prop firms develop programs to assist beginners in learning while they demonstrate their abilities. Although many fail, disciplined newcomers can succeed by following strict risk management rules.

5. Remote Traders Worldwide: Online prop firms enable individuals from anywhere to participate, creating a global opportunity. This accessibility has contributed to its rapid growth in recent years.

Tip for aspiring traders: Prop trading relies less on experience and more on risk management and consistency. Firms favor traders who manage risk well and deliver consistent returns over those seeking large but risky profits.

How to Start Prop Trading – Step by Step

Getting started in prop trading is straightforward if you follow a structured approach. Here are the key steps:

1. Research and Choose a Reputable Prop Firm: Look for firms with strong reputations, clear rules, and positive reviews. Check if they are regulated or well-established to avoid scams.

2. Understand the Evaluation Process: Most firms require you to pass an evaluation challenge, which usually includes:

• Reaching a profit target (for example, 8–10%).

• Staying within loss limits and drawdown restrictions.

• Following risk management guidelines.

3. Pay the Evaluation Fee: Participants typically pay an upfront fee to engage in the evaluation. Fees vary based on account size and can range from $100 to over $1,000.

4. Trade the Evaluation Account: Utilize your skills to demonstrate consistency. Adhere to the rules, trade patiently, and steer clear of excessive risks. Passing the evaluation is more about steady performance than making one big win.

5. Get Funded: After you pass, you’ll receive access to a funded account (like $25,000, $50,000, or more). At this point, you are trading the firm’s money under strict rules.

6. Manage Risk and Grow: Trade with discipline by using proper position sizing, avoiding impulsive trades, and focusing on consistent results. Many firms offer scaling plans to increase your account size as you demonstrate steady profitability.

Beginner Tip: Keep a trading journal during both the evaluation and funded phases. Documenting your decisions helps you identify patterns and enhances your long-term performance.

Quick Glossary of Prop Trading Terms

• Prop Trading (Proprietary Trading): Trading using a firm’s money instead of your own, with profits shared between you and the firm.

• Evaluation / Challenge: A test phase where traders must meet profit targets and follow risk rules to qualify for a funded account.

• Funded Account: The trading account given by the firm once you pass the evaluation. You trade with the firm’s money.

• Profit Split: The percentage of profits you keep versus what the firm takes. Common splits are 70/30, 80/20, or 90/10 in favor of the trader.

• Drawdown: The maximum loss allowed from your highest account balance. Exceeding this may lead to account termination.

• Daily Loss Limit: A strict rule that limits how much you can lose in a single day. Breaking this rule usually results in losing your account.

• Scaling Plan: A program where the firm increases your account size as you show consistent profits.

• Overnight Rule: Some firms restrict holding positions overnight or over weekends to minimize risk.

• Reset Fee: A fee paid to restart the evaluation if you fail by breaking the rules.

• Risk Management: The process of controlling trade sizes, losses, and overall exposure to protect capital.

• Leverage: Borrowed money that allows you to control larger positions with less of your own capital. Prop firms often set limits on leverage.

Prop Trading Examples

To illustrate how prop trading works in practice, let’s look at two simple scenarios.

Example 1: A Winning Trade

• Setup: You trade a $100,000 funded forex account with an 80/20 profit split.

• Action: You earn a 5% gain for the month (+$5,000).

• Outcome: You keep $4,000, and the firm takes $1,000.

• Lesson: With access to large capital, even small percentage gains can lead to significant income.

Example 2: A Losing Trade

• Setup: Same $100,000 funded account with a daily loss limit of $2,000.

• Action: A bad trading day results in a $2,100 loss.

• Outcome: You break the rule, and the account is terminated.

• Lesson: Prop trading is more about protecting your account by following the rules than chasing big wins.

Tip for beginners: Treat a funded account as if it were your own savings. Emotional discipline and effective risk management distinguish successful prop traders from those who struggle.

Final Thoughts / Next Steps

Engaging in prop trading offers a compelling opportunity to access significant capital without putting your own money at risk beyond the evaluation fees. It offers advantages like profit sharing, advanced tools, and opportunities for growth, but it also comes with strict rules and the risk of losing your funded account if those rules are broken.

If you’re thinking about prop trading, here’s a simple roadmap to follow:

• Educate yourself first: Understand how evaluations, drawdowns, and profit splits work before committing.

• Start small: Choose an evaluation with a modest account size to practice discipline without too much pressure.

• Respect the rules: Most accounts are lost due to rule violations rather than poor strategies.

• Focus on consistency: Aim for steady monthly returns instead of trying to hit it big with one trade.

• Choose wisely: Work only with well-known, reputable prop firms that are clear about their conditions.

Engaging in prop trading does not guarantee wealth. It represents a professional partnership where your success hinges on discipline, patience, and effective risk management. With the right preparation, it can be a powerful way to grow your trading career and access markets that you couldn’t reach on your own.

Legal Disclaimer

This content is for educational purposes only. Nothing on this page is financial advice or a solicitation to buy or sell any security, derivative, or proprietary trading program. Trading involves risk. Past performance does not guarantee future results. Always check the firm’s licensing and reputation on official regulatory registers.

Beginner FAQ

What is prop trading in simple terms?

Prop trading is when you trade using a firm’s money instead of your own. You keep a share of the profits while following the firm’s rules.

How does prop trading work?

You usually start by paying an evaluation fee and trading a demo account under strict rules. If you pass the challenge by meeting profit targets and staying within loss limits, you get a funded account. Then, you trade the firm’s capital and share the profits.

Is prop trading legal?

Yes, prop trading is legal in most countries. However, some firms may be unregulated or operate in ways that raise concerns, which is why some traders confuse “risky” with “illegal.” Always research the firm’s reputation before joining.

Why is prop trading illegal?

Prop trading itself is not illegal. Some firms may break regulations or operate scams. The activity is legal, but using unregulated or fraudulent firms can put your money at risk.

How do prop traders get paid?

Most prop firms pay traders monthly or bi-weekly. Payments are usually sent via bank transfer, PayPal, or other methods after profits are split according to the agreement (e.g., 80/20).

How much can I make with prop trading?

Earnings depend on your performance, account size, and the profit split. A 5% monthly gain on a $100,000 account could mean $3,500–$4,500 profit after the firm’s cut.

Do I risk my own money?

Usually, the only money at risk is the evaluation fee. Once funded, losses are covered by the firm as long as you stay within their rules.

Is prop trading a good idea?

It can be if you have strong discipline and risk management skills. Prop trading gives you access to larger capital without risking much of your own, but it’s not easy. Many beginners fail evaluations before learning to succeed.

Is prop trading good for beginners?

It can be, but beginners should expect a steep learning curve. Passing evaluations requires patience, strategy, and strict rule-following.

What happens if I break the guidelines?

Your account is usually terminated immediately, and you may need to pay a reset fee to try again.

Can I trade any market with a prop firm?

It depends on the firm. Most allow trading in forex, indices, commodities, and sometimes crypto or shares, but restrictions vary.

This article was written by Itai Levitan at investinglive.com.