How Do Prop Firms Make Money?

Prop firms may appear too good to be true for some traders. Where do prop firms get the money? Are they trading on real or demo accounts? Does anyone ever get funded and do prop traders make money? These are just a few of the questions that you may have if you are thinking about taking part in a trading challenge to get a funded account with a prop firm.

Proprietary trading firms are shrouded in so much mystery because they have experienced such rapid growth in recent years. We’ll delve behind the scenes in this article to see how exactly prop firms generate revenue.

How Do Prop Trading Firms Make Money?

For prop firms, there are two main business models. The first is the challenge model, in which traders pay to participate in a trading challenge, the majority of which fail. This generates income to compensate successful traders. The second type is the profit split model, where the prop firm provides the trading capital in exchange for a percentage of any profit that prop traders make on the funded account which they provide.

In spite of the fact that there are various prop firms in the market today, most of them operate according to the same strategy. Proprietary firms typically aren’t too forthcoming with information about their financial operations or where all the money for funded accounts comes from, making them appear elusive and secretive.

That being said, prop firms employ one of two business models to generate revenue or a combination of both. The challenge approach is used by the vast majority of prop companies whereas the best prop trading firms also provide real funded accounts with a profit share.

Prop Firm Trading Challenges

The challenge model is the most typical business model for prop firms, as was already mentioned. Here, a trader will purchase a trading challenge from the prop firm with a view to meeting the challenge objective in order to qualify for a funded trader account. The aspiring prop trader will be charged a fee for this.

Technically speaking, this means that the prop firm is now profiting off unsuccessful traders. In fact, some would argue that the prop firm wants the bulk of the traders to fail because that way they will never ask for withdrawals. However, they are missing the fact that the prop firm can also get a share of the profits by proving real funded accounts to traders who do manage to pass the trading challenges that they have paid for. This is a win/win situation for both trader and prop firm.

Some prop firms implement extremely rigorous trading restrictions with the knowledge that 90% of traders will refuse to comply with them because they stand to profit from them. As a result, the company can engage in trading against traders, which presents the same problem as trading with an unregulated broker and market maker. This is one of the key causes of the difficulties in overcoming prop firm challenges.

You will often find that a prop firm which is making money from challenges will only provide demo accounts rather than actual money to fund successful traders. The funds from unprofitable traders losing the challenge is used to pay the trader if they are successful and request a payout. These proprietary trading firms function in a manner that is nearly Ponzi-like in this regard. Traders generally aren’t aware of this. It’s crucial to comprehend how you are truly receiving the profit split on your funded account and look for evidence of payouts from other traders. The prop firm money may run out if too many traders make excessive profits.

Prop Firm Profit Share

The profit split model is the original business plan for a prop company and the model some of the top prop firms such as FTMO use. With this business strategy, having successful traders is excellent for the company. This is especially the case if they are providing instant funded accounts and are solely compensated by successful traders. Every time a successful trader requests a withdrawal from their funded account, the prop firm will deduct a profit split from their withdrawal. This implies that if a trader is not successful, they will not receive any money from them. The difference is that prop firms who make money from a profit share truly want to attract and keep profitable traders, as this is in their best interests. Furthermore, if they are trading with real capital, any losses they experience will usually always be covered by the prop firm which is a great advantage to prop traders.

For prop firms, the problem with this business model is the prevalence of unsuccessful prop traders and traders who are unable to maintain a constant risk level. For this reason, some of the top prop firms will provide training resources to help traders improve their skills and strategies because they require profitable traders. It has been known for prop firms to have an improved success rate when they take the time to educate traders. It’s crucial to make sure the prop firm that you deal with is compensated for your achievements rather than your failures.

Other Ways Prop Firms Make Money

In addition to charging for trader challenges and taking a profit share, prop firms also make money from other sources. This could be a charge to access educational content or specialised platforms and tools. They may have a partnership deal with a brokerage firm who pays them an ongoing commission for any clients that they introduce. The reset fee is another way to charge traders again if they fail a trading challenge the first time round.

Where Do Prop Firms Get Their Capital?

One of the most popular question traders ask is where do prop firms get their money? Are prop firms a scam that just want to make money from charging fees for impossible challenges that will never lead to a funded account? Before deciding which type of prop firm and funded account is appropriate for them, all traders should be aware of this excellent question.

Since traders frequently fail their challenges, prop firms adopting the challenge strategy to make money are typically cash rich. They typically start out as very small businesses with no institutional support and a lack of the infrastructure that many financial instructions have. On the other hand, venture funds frequently make significant investments in or even provide funding for prop firms that only rely on profitable traders for their income. This is because trading liquidity is extremely important to prop firms.

Traders who are only successful on demo accounts are of little use to them because they can lose money when the trader does with real capital. Prop firms that follow this business model must therefore always have a large amount of capital on hand and available to give to traders who can consistently make profits.

Final Thoughts

In conclusion, there are two main ways to how prop firms make money. This is either from traders who pay for and then fail challenges or from a share of the profits made by successful traders. A prop firm that uses a combination of both could be considered the sweet spot. It is quite rare for a prop trading firm to provide instant funds without taking the time to provide you with a trading challenge and analyse your performance before making a financial commitment themselves.

Prop Trading Firms

Prop Trading Firms is a website dedicated to reviewing prop trading firms. With an increasing demand of aspiring traders who are looking to get a funded account, there are more and more prop trading firms popping up nowadays. We can help traders to find the prop firms that meet their needs.