What Is Proprietary Trading and How Does It Work?

Proprietary trading means a firm trades its own money to make a profit for itself. It does not place orders for clients or earn a fee on them. Every gain and every loss belongs to the firm.

The term now covers two quite different worlds. One is the trading desk inside a bank or a trading house. The other is the retail prop firm, which backs outside traders who pass a test. This guide explains how the money flows in each one.

The basic idea

Most financial firms earn money by serving clients. A broker charges a commission or a spread on each order. A fund manager charges a yearly fee on the money it runs. In both cases, the client carries the market risk.

A prop trader flips that model. The firm puts its own capital on the line and keeps what the trading makes. If a trade loses, the firm takes the whole hit. That is why prop shops care so much about risk limits. One careless trader can wipe out the gains of several careful ones.

Prop trading at banks

For many years, large banks ran prop desks next to their client business. Those traders placed bets with the bank's own money on bonds, stocks, currencies and derivatives.

That changed after the 2008 financial crisis. In July 2010, the United States signed a major banking reform into law. One part of it became known as the Volcker Rule. It limits banks that hold insured customer deposits from trading for their own account.

The rule still allows some trading. Banks can make markets for clients, underwrite new deals and hedge their own risks. But pure bets with the bank's own capital are now largely off the table there.

Independent trading firms

Outside the banking system, many firms trade only their own money. They do not take deposits from the public, so the Volcker Rule does not apply to them in the same way.

Some of these firms run computer models that trade at very high speed. Others hire human traders who make their own calls within a set budget. In both cases, the firm sets strict limits on how much each trader can lose in a day.

The retail prop firm model

In recent years, a newer type of firm has grown fast online. These firms offer trading capital to almost anyone who can pass a test. You do not need a finance degree or a job on a trading floor.

The deal is simple. You pay a fee and trade a practice account under set rules. If you meet every condition, you get a funded account. After that, you keep an agreed share of the profits you make.

How the evaluation works

Every test has a profit target and a set of loss limits. The target shows your strategy can make money. The limits show you can control risk. Many traders find the limits much harder to respect than the target.

A two step prop firm splits the test into two phases, each with its own profit target. One common setup asks for 8% in phase one and 5% in phase two. Both phases often carry a 5% daily loss limit and a 10% overall loss limit. Other firms use a single phase, and the exact rules vary a lot between firms.

Some firms add more rules. You may need to trade on a minimum number of days. A consistency rule may stop one huge day from making up most of your profit.

What happens after you pass

Once funded, you keep trading under similar loss limits. Profits are split between you and the firm. Many firms quote splits between 70% and 90% in the trader's favor.

Payouts usually run on a fixed schedule, such as every two weeks or once a month. Break a rule and the firm can close the account. So read the payout terms before you start, not after your first good month.

How these firms make money

Retail prop firms mostly earn in two ways. The first is the fee traders pay to take the test. The second is the firm's share of profits from funded accounts. Knowing this helps you judge their offers with a clear head.

What to check before you sign up

There is no single Best Prop Firm for every trader, because the right choice depends on your style and your markets. A scalper and a swing trader need very different rules. So start with the published terms, not the marketing.

• Loss limits: check if the overall limit stays fixed to your starting balance or trails your highest balance.

• Profit targets: make sure each target fits the returns your strategy made in testing.

• Time rules: look for minimum trading days, deadlines and limits on holding trades over the weekend.

• Payout terms: note the profit split, the payment schedule and any rule that could delay a payout.

• Markets and platform: confirm you can trade the pairs and use the software you already know.

• Fees and refunds: find out what a reset costs and whether the fee is ever returned.

Is prop trading a good fit for you?

Prop trading suits people who already have a tested strategy. They also need the discipline to follow it every day. It lets you trade a bigger account than your savings would allow. It also caps how much of your own money is at risk.

The trade off is a set of strict rules with little room for a bad week. Most of the skill lies in controlling losses, not chasing gains. Practice on a demo account first and record every trade. Take a test only once your results hold up.