Prop firms make money in a variety of different ways. These profits are not consistent as they can vary depending on a number of factors including the funded trading accounts that they offer and the quality of their prop traders. In this article we will explore how prop trading firms make money and how much they can make.
How Do Prop Firms Make Money?
Between 10% and 50% of each prop trader’s income go to prop trading firms. Users must pay to open accounts with them as well. A select few divide profits at a 90:10 ratio, which means they receive merely 10% of each trader’s gains. Some may charge traders for instruction and professional coaching. They might partner with a broker and earn a one-off or ongoing commission from the prop traders that they prefer. The main income is no doubt through trading challenges which some users take multiple times. They can range anywhere from $50 all the way into the thousands.
Are Prop Firms Profitable?
Prop trading firms are profitable, which is why we have seen more and more open their doors in recent years. They just need to provide trading challenges for a fee and promise a funded account for those who pass. The prop firm can then start promoting their services to an ever-increasing pool of aspiring prop traders. Each time someone signs up, they are making a profit and all they need to do is create a simulated account for the evaluation process.
Some sceptics believe that prop firms do not even fund traders and make traders jump through hoops to avoid giving them a funded account and paying out profits. These scam prop firms cannot be sustainable because eventually users will catch on and start leaving bad reviews. For the honest prop firms out there, this can make things difficult for them. However, if they do provide a funded account then they can get a share of the prop traders profits.
Can Prop Firms Lose Money?
Yes, there are ways in which prop firms can lose money. The main downside being that they need to take on all the risk. This is why there are trading challenges in place to filter the good from the bad prop traders. It would be extremely risky to give a funded account to anyone and everyone. They are looking for consistent traders with a proven track record and sensible money management.
Advertising costs can be very high for a prop firm looking to attract clients. This is because the industry is so competitive due to the ease of getting started. The best prop firms need to think outside of the box and attract new traders with unique incentives and favourable trading conditions. They may need to invest time and energy into provide users with educational resources and mentoring to make them better prop traders.
Are Prop Firms Regulated?
Only to the extent that they wish to be, is the most straightforward response. Proprietary trading companies are exempt from regulation because, by definition, they exclusively trade their own funds. Although many proprietary firms do not, some do register with securities groups.
Only if they are also acting as a broker-dealer must a proprietary trading business register with the Securities and Exchange Commission and a registered national securities association, such as the Financial Industry Regulatory Authority (FINRA).
Prop trading companies who opt not to function as broker-dealers and don’t “conduct securities transactions and business with the investing public in the United States” are exempt from the requirement to join FINRA. The word “public” is crucial since it denotes that businesses using their own private funds are exempt.
As long as they adhere to certain exemption criteria, even those prop firms that do act as broker-dealers can avoid the SEC’s requirement that they join a securities association.
Proprietary trading companies that give funded accounts to any traders who can present effective trading methods also elude regulators. Because these prop companies don’t view themselves as financial organizations and frequently employ demo accounts with their traders, they are exempt from securities requirements.
Large banks are the only establishments where proprietary trading is governed. Due to their involvement in the 2008 financial crisis, large banks who once had their own prop trading desks are no longer allowed to engage in proprietary trading.
Most prop trading firms make profit from the trader challenges. You will not usually receive a refund if you pay the price to take the challenge and you are unsuccessful. However, they will usually allow you to take part in the challenge again as this allowed them to earn more money from one trader. Some prop firms make the evaluation phase difficult on purpose in order to try and avoid having to fund traders so they can keep making bank from trading programs without needing to pay a profit share.
On the other hand, there are honest proprietary firms that will give successful prop traders a funded account because they want to try and make more money from a profit share. In this instance, the profits can be long-term, but it does mean that they take on additional financial risk. There are other ways prop firms can earn money, including educational content, trading tools and one to one mentoring.