Proprietary trading firms, commonly referred to as prop firms, are becoming increasingly popular in the modern financial landscape. Why? Due to their ability to offer traders a unique opportunity.

That of engaging in the financial markets with substantial capital provided by a third-party entity.

This approach promises significant profits. However, behind this attractive prospect lies a complex reality, which it is imperative to demystify before jumping in headlong.

Understanding how prop firms work, and their advantages and disadvantages, is crucial if you’re looking to get started in trading.

This guide aims to provide a comprehensive overview of what prop firms really are, how they operate, and what you should keep in mind before getting involved.

What is a prop firm?

A prop firm is a company that offers external traders the opportunity to benefit from its capital to operate on the financial markets.

These firms specialize in a variety of financial products such as cryptocurrencies, stocks, bonds, Forex or commodities.

Prop trading therefore represents a lucrative opportunity for traders, enabling them to access substantial trading funds without exposing their own capital.

Working with a prop firm means using the company’s funds and sharing in the profits generated.

Nevertheless, this is in return for validation of your trading skills.

This is usually done through challenges, carried out before the funds are released.

However, the profitability of this activity depends above all on the trader’s skills. As a result, prop trading is primarily aimed at experienced traders.

With solid trading experience and in-depth knowledge of the financial markets. These opportunities are less suited to beginners and occasional investors.

In fact, prop firms require more extensive training and supervision to master the details of trading.

Indeed, without a solid foundation, the experience is likely to be not only unsuccessful, but also short-lived.

Prop firms are of particular interest to independent traders looking to benefit from larger trading funds without taking personal risks.

They are also attractive to traders who prefer to operate with substantial funds without depending on the financial structures or supervision of banks and finance companies.

However, underneath their attractive appearance, prop firms have their own particular operating and business model that it is important to understand.

How does a prop firm work?

To start trading via a prop firm, traders are usually required to submit an application and pass a skills assessment, known as a “challenge”.

Although there are a few prop firms that dispense with this challenge, their rarity is often a bad omen.

Passing prop firms challenges

These prop firms challenges are paid for and enable companies to select qualified traders and limit their risks.

It also enables them to make money from the failure of many traders who enter the challenges.

Challenges are carried out on demo accounts with virtual funds, during which the company in question establishes rules to be followed and success criteria.

Usually, a profitability target as a percentage of initial capital and a maximum daily loss limit are set.

Depending on the prop firm, the challenge process may differ. The duration of the challenge may be shorter or longer.

The most serious companies require challenges lasting 30 or 60 days. Others offer challenges lasting just 24 hours.

Some companies set up a two-phase process. This means that the trader must pass a first challenge under certain conditions.

This is followed by a second, confirmatory challenge, before the trader can trade with the company’s funds.

Yet, as you would expect, few traders make it all the way. Statistically, only 19% of traders make it through phase 1 of the challenge. Of these 19%, 42% pass phase 2.

Overall, only 8% succeed in both phases of the challenge. In reality, most of those who embark on this challenge have no clear strategy, no established risk and money management.

Very few have the fundamental foundations needed to face such a challenge successfully.

What happens once the challenge has been met?

Once traders have successfully completed their challenge, their account is funded with capital equivalent to that chosen for the challenge.

This enables them to start trading in earnest. The company also refunds the amount paid by the trader for the challenge.

In addition, prop firms usually provide a free trading platform and sometimes expensive tools. To offer traders an optimal trading environment.

Traders take responsibility for their own trading decisions and are free to choose the products and strategies they wish to use.

Nevertheless, they must comply with certain rules established by prop firms. These include leverage limits and position hedging requirements.

Moreover, in the event of substantial losses, the prop firm account may be closed. The same applies to failed challenges.

These limitations are set at the time of registration and vary from one prop firm to another.

It’s crucial to pay attention to the conditions before choosing one.

Some prop firms apply a consistency rule, requiring traders to always achieve results within a range determined by their average activity.

Profits generated outside this range cannot be withdrawn. Others apply a 50% first-pay principle.

This means that, in all cases, the trader will only be able to withdraw 50% of his winnings on the first payment.

Prop firms generally charge a commission on traders’ profits. This commission varies from company to company. This commission may be fixed or proportional to profits.

It may be deducted from profits before or after tax.

In addition, Prop firms may charge trading fees such as spread fees or commissions on each transaction carried out.

In general, the trader receives between 70% and 90% of the profits made with the borrowed capital.

And if the challenge is unsuccessful?

If the trader fails his prop firm challenge, he loses the amount paid to undertake the challenge.

However, he can try again as many times as he likes, but the registration cost will remain unchanged, and he will have lost the amount paid for the previous challenge.

What are the advantages and disadvantages of Prop Firms?

Advantages

Prop Firms offer a multitude of advantages to traders looking to get involved in the world of trading.

Here is an overview of some of the positives they can offer:

• Access to substantial trading funds
• Losses are limited to the company’s capital after successful testing
• Accessible to small amounts of capital
• Challenge reimbursed if successful
• Low risk for the trader

Disadvantages

However, working with a Prop Firm also presents certain disadvantages and constraints that need to be carefully considered:

• The need to pass skills tests (Challenges), for which a fee is charged.
• Profit sharing can be very high, depending on the prop firm.
• Many dishonest companies
• Very restrictive conditions, depending on the prop firm
• No regulation, so impossible to win in the event of a problem
• prop firms’ real interest is traders’ losses

Risks associated with prop firms

Prop firms operate in an environment where risk is omnipresent. One of the major risks lies in the very business model of these companies, which focuses on managing challenges and traders to generate profits.

Indeed, the prop firms business model is partly based on the fact that some traders fail.

Challenge fees and associated costs are a source of revenue for the firm, irrespective of the traders’ results.

Working with company money in prop trading involves a certain amount of risk.

Even if the pressure is not on their own capital, some less-experienced traders may feel the psychological burden of operating with amounts far in excess of what they are used to.

The relevance of challenges is crucial and should not be underestimated.

They offer benefits for both the company and the trader, helping to determine whether or not the trader is suited to this activity.

Prop trading is prone to fraud. It is therefore essential to choose with care the prop firm with which to associate.

Challenge fees can be very lucrative for fraudulent platforms, which bank on the failure of aspiring prop firm traders to enrich themselves.

Relying solely on the opinion of the Autorité des Marchés Financiers (AMF) is unreliable. Indeed, the AMF’s blacklist sometimes lists trusted companies, causing confusion within communities, as was the case with FTMO.

Therefore, it is better to cross-reference information sources and traders’ opinions to make informed decisions. In other words: do your own research!

It is also important to note that prop trading can involve the risk of conflicts of interest, if traders are encouraged to make trading decisions that are not in the company’s best interests.

To avoid this type of conflict, it is advisable to choose a prop firm that adopts sound and transparent governance practices like PIUP.

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