Prop firms are gaining popularity among retail traders in recent years. They appear to be a decent choice for aspiring traders, particularly for novices. Some may argue that they seem too good to be true. As a result, many traders wonder if prop firms are legitimate or simply a scam?
What Are Prop Firms?
We should define the terms before evaluating whether or not prop firms are legitimate. So, what exactly are they? Proprietary firms, or prop firms for short, are businesses that hire and fund traders to engage in market activity on their behalf. Some will even provide education and train them to become professional traders who can make a career from prop trading.
In order to trade with capital from a prop trading firm, you will usually have to pass a trading challenge. This will have profit targets and other objectives that you need to achieve in order to succeed. Should you pass the evaluation phased whilst adhering to all of the rules, you can get a funded account. The profits generated are then shared between the trader and prop firm.
In theory, anyone can take part in a prop firm challenge to try and obtain a funded account, regardless of their experience level. You just need to choose a funded program and show them you have got what it takes. They will even cover the risk on the account. This may seem too good to be true, which is many people ask if prop firms are legit.
How Do Prop Firms Make Money?
There are a variety of ways in which prop firms make money, but their main income is from charging for trader challenges. They can offer a variety of challenges that range in prices, from as low as $50 and all the way into the thousands. If they attracted 100 prop traders at $100 per challenge, this would generate an income of $10,000. Some traders may even fail and pay to retake challenges, some might even purchase multiple accounts.
If a trader passes the evaluation phase, they should be given a funded account. The prop firm provides the capital for the trader, and can keep anything from 10-50% of the profits that they make. For instance, if a prop trader makes $5,000 in one month and the prop firm has a 20% share, they would see an income of $1,000 without doing anything other than proving the capital.
Other ways prop firms make money can be from charging for educational content, mentorship, trading tools and data feeds. As mentioned above, retake fees are another source of income along with a reset fee for traders who want to start their challenge fresh.
Are Prop Firms Legitimate?
The simple answer to this question is yes, prop firms are legit provided you are dealing with a reputable company. However, now that you understand some of the ways in which prop trading firms make money, you can understand ways in which some prop firms might not be legit.
Firstly, if they are getting a consistent stream of income from traders paying for challenges, why would they want to give them a funded account. This increases their risk exposure and they will need to make payouts to successful traders. Even if only a small percentage of prop traders were making profit, this could still cost them a lot in payouts.
This is why many believe prop firms make challenges very difficult with hidden rules to try and cause traders to fail so they don’t have to give them a funded account. Even if they do give them a funded account, it might not be using real funds. Some prop firms just use demo trading accounts so they don’t even need to put the money up for so called funded traders. They might then come up with all sorts of excuses to not pay out, because the profit would be coming directly out of their pockets.
On the other hand, prop firms cannot simply give a funded account to anyone. Whilst there are instant funding prop firms, it would be very risky for most of them to fund a trader without seeing what they can do. This is why the evaluation process is necessary and a fee acceptable because it costs them time and resources to get the challenge setup.
It is normal for the trading rules to be strict as they want to find consistent traders with sensible money management. Some traders might think a prop firm is not legit simply because they did not read the terms correctly and failed the challenge. However, legit prop firms should provide you with capital to trade as promised if you do pass.
Why Are Prop Firms Not Regulated?
The overwhelming majority of prop firms are unregulated. Why do they not have the same responsibilities as, say, Forex brokers if they are dealing with money? Prop firms are first and foremost working with their own funds, not those of third parties. Prop firms can escape the majority of rules because of this alone.
Also, many prop companies deprive traders of actual money to handle. Even traders who have passed testing and been granted access to a “real” account with these organisations continue to trade with virtual money on demo accounts. Technically, this indicates that no trading or other financial activities are happening. Indeed, the company can duplicate profitable trades made by financed traders on the company’s real account. But once more, those are transactions funded by the firm’s own funds.
In general, prop businesses maintain that neither they nor they are financial institutions or offer financial services. “Financial education” is the most typical method that prop businesses advertise what they are giving. It raises concerns for some regulators, and it’s feasible that future law would mandate that Forex prop businesses be subject to the same regulations as Forex brokers. Nonetheless, for the time being, most prop businesses are able to get around rules while continuing to operate within the law.
The absence of restrictions isn’t always a negative thing. Theoretically, it makes obtaining funding from prop companies easier and less expensive. However, one must not overlook the fact that there are no safeguards for dealers, which is the main issue with a lack of regulation. So, it is entirely up to the traders to determine whether or not to trust a certain prop firm. The next question is particularly significant in light of this.
How to Check If A Prop Firm Is Legit?
The quickest and easiest way to check if a prop firm is legitimate is to see what the user feedback is. You can read prop firm reviews and ask them if they have any proof of payouts that you can verify with the trades themselves. Just be wary, some prop firms may use false statements and paid actors in order to try and entice unwitting traders.
Check to see the partners that the prop firm is working with. If they have deals with top brokers in place and integrate leading platforms, this can be a good sign that the prop firm is legit. You could also consider the payment provider they use. If they are using a reputable processor, they will need to be avoiding complaints. If they only accept crypto for example, this could be a red flag.
Is Prop Trading Legal?
The very short answer is no, proprietary trading is not illegal, unless you are a trader at one of the large banks. Thanks to the billions of dollars of losses they suffered during the 2008 financial crisis, banks are no longer allowed to proprietary trade.
According to the Volcker Rule, banks and organizations that hold banks are not allowed to engage in proprietary trading, own hedge funds, or participate in private equity funds. Banks prioritize satisfying consumers from a market-making perspective, and revenue is based on commissions.
The rule aims to restrict banks from making certain speculative investments that do not directly benefit their depositors. The law was proposed after the global financial crisis when government regulators determined that large banks took too many speculative risks.
Are Prop Firms Legal?
To become a self-employed prop trader, there are no regulations. Moreover, independent prop trading is neither specifically prohibited by any laws or regulations, nor is it subject to any of them. The only thing that counts is whether you’re trading for customers and providing your skills as a trader.
It’s challenging to define what “independent” means because there isn’t much legal precedence for independent prop trading. Would you be regarded as an independent trader, for instance, if you work for a prop business but also manage the private equity funds of other people in addition to trading your own money? Would you still qualify as an independent trader if you only traded your own money rather than managing money for others?
Generally speaking, prop firms should be legal if they are not handling client’s funds and just providing a service which does not need to be regulated. However, this can vary depending on the country and jurisdictions that they operate in. You should always check to make sure the prop firm is legit and following all required regulations.
To conclude, there are legit prop trading firms, but not all are treated equally. You will no doubt read lots of stories about unhappy traders who passed a challenge and did not get a funded account. You will also read about traders who made a profit on a funded account and didn’t get a payout. Just like in any industry, there are going to be good and bad apples. By applying what you have learned in this article, you can make sure that you choose a legit prop firm that can be trusted.