Proprietary trading, also known as “prop trading,” is relatively simple as far as trading concepts go: It refers to when traders trade securities such as stocks, bonds, derivatives, or any other kind of financial instruments with the firm’s own money, also referred to as the nostro account, rather than with clients’ or depositors’ money. The idea is to make money for the firm directly, rather than for its clients.

Read on to learn more about proprietary trading and what it takes to become a proprietary trader.

What Is Proprietary Trading?

Proprietary trading occurs when a trader trades financial instruments with a firm’s money. Once upon a time, banks used to operate on a fairly simple and straightforward model: They would take in deposits from individuals, families, and businesses, then turn around and reinvest that money. The investments were aimed at making a profit for themselves as well as generating a return for the bank’s customers in the form of interest.

However, government deregulation throughout the 1980s and 1990s led banking to become a far more complex business. Along with investing their customers’ money, some banks now make investments using their own cash. This practice is known as proprietary trading, or the “prop desk” by bank employees. By investing their own capital, banks can leverage proprietary trades to maximize their overall returns. Proprietary trading often involves trading stocks and bonds, but it can also involve trading other kinds of instruments, such as currencies and commodities.

Becoming a Proprietary Day Trader: What it Takes

Some day trading firms will also set traders up with the opportunity to engage in proprietary trading by making trades with the firm’s money. The trader then receives a portion of his or her overall earnings through trades, so the arrangement benefits everyone. Proprietary day traders do not have clients other than the firm itself, which means they do not have to generate leads or make cold calls to find prospective customers, a benefit many prop traders enjoy.

Like other kinds of day traders, prop traders do not care about a company’s underlying fundamentals or where its stock might be in a few months to a year. They are not investors or financial advisors. Rather, they aim to make a profit off quickly executed, lucrative trades over the course of hours, minutes, or even seconds.

Of course, proprietary trading comes with challenges you should be aware of before leaping in.

Proprietary day traders usually work as contractors rather than as employees. This means they usually don’t get benefits or even hourly wages or salaries. Rather, their take-home pay is in the form of a cut of the profits they generate, which can take weeks or even months to appear. So to start out as a proprietary day trader, you’ll need a reasonable financial cushion, as well as life circumstances that allow you to take a certain amount of risk.

Proprietary traders use a variety of strategies. Some prop traders will make many — even numbering in the hundreds — of small trades throughout the day. Others only make a few big trades each day. Some proprietary traders only work for certain hours of the day or days of the week, while others trade all day. Because trades are executed quickly, day traders don’t need to monitor the market constantly and can jump in or out of the market more or less as they please.

At some firms, prop traders work out of an office and have a desk, whereas other traders can work from home. Prop traders who work from home, however, are usually those who have more experience and a proven track record of success. Some firms are willing to hire beginner prop traders, while others will only hire those with experience generating profitable trades.

The Benefits of Prop Trading

Proprietary trading comes with a number of benefits, both to the commercial bank or financial firms that engage in it and to the traders themselves.

While prop trading might represent a relatively small percentage of the overall gains a firm generates, it still allows them to realize 100% of those gains from trading, rather than earning profits in the form of fees and commissions from investments made on behalf of clients.

Second, prop trading allows a financial institution to stockpile an inventory of financial securities. This is useful to the firm because speculative inventory offers a benefit to clients and because it helps institutions buffer against illiquid or down markets when it becomes more difficult to trade on the open market. Also, prop trading allows financial institutions to increase their market-making influence by providing them with liquidity on a specific type of security or asset.

There are also a number of benefits to becoming a prop trader working for a firm that engages in proprietary trading. First, many prop traders love being surrounded by “their people” — other traders. This allows you to learn from your friends and share your knowledge with others. Ultimately, everyone wins and ideally becomes more profitable.

Being a prop trader also typically gives you access to much more capital than you would have on your own. You don’t need to worry about the $25,000 minimum account balance required for day traders.

Prop traders can also benefit from lower commissions than what retail day traders make because they only need to split their profits with the firm; they don’t have to cut in a client, as well. Prop traders can also reduce their own costs by working with a larger firm, rather than trading on their own.

Finally, becoming a prop trader gives you access to the most talented day traders. So as a proprietary trader, you have the opportunity to learn from on-the-job experience as well as from the wisdom of expert traders who have seen it all and know the markets like the backs of their hands. If you’re new to prop trading, then getting proper training is especially important to your long-term success.

The Cons of Prop Trading

Of course, it’s also important to be aware of the downsides of prop trading for a firm versus trading on your own.

Some firms no longer have brick and mortar businessrs but simply conduct all their business online, which means all employees work remotely. In this case, you won’t have a desk in an office full of experienced traders who can show you the ropes. Of course, you can still access traders via phone or online tools such as Skype, but that might not be the same as hanging out around the water cooler or after work. With more firms going online, competition for physical seats on the trading floor has become even fiercer.

Additionally, retail technology has reduced the advantage prop trading firms used to have. Because individual traders now have access to high-speed internet and online trading firms, they can rival the speeds and resources of prop traders operating with bigger firms.

While we’ve already mentioned that prop traders make more profit per trade than retail day traders because they don’t have to contend with clients, it’s also possible for some retail day traders to negotiate improved commission rates directly with their brokers.

Finally, some firms will charge their prop traders fees, such as software access fees, seat rental fees, and marked-up commissions that take an additional chunk out of your overall profits.

Conflicts of Interest

Proprietary trading also has the potential to generate conflicts of interest between the firm’s own trading business and its customers. For that reason, investment banks must have a firewall between their investment and trading divisions. And in the wake of financial scandals like Enron’s, these divisions have come under even closer scrutiny.

Do you want to learn more about proprietary trading and day trading prop firms? Look no further than RagingBull. Our goal is to educate traders so they can learn everything they need to know to start making money through trading. Our team of expert traders is standing by to help you make more cash on the market. Our experts are millionaires and expert traders themselves, so they are prepared to show you the ropes.

To start learning more today, check out our online education center, or set up an appointment with one of our experts on a schedule that works for you. Get ready to make more cash trading securities today.

Jeff Williams

Jeff Williams is a full-time day trader with over 15 years experience. Thousands of entry-level and experienced traders alike – day-traders and swing-trade small cap stock traders – credit Jeff with guiding them to turning small accounts into big accounts.

Jeff’s "Small Account Challenge" shows people how to transform accounts from a few thousand dollars into $25k, $50k or even $100k.

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