Given the recent emergence of prop trading firms, retail traders should consider if this option is a better investment of their time and funds compared to trading with regular brokers.
An overview of prop trading
For those who are unaware of what proprietary trading is, essentially it is trading using third-party funds (you could think of it as sponsored trading). Rather than depositing one’s own money into a regular broker account, the account is instead funded by a firm, intending to split the profits the trader earns. The concept itself is not new, since trading on behalf of wealthy entities, as well as other forms of commission-based asset management, existed long before this. However, the opportunity for widespread participation in prop trading is certainly new.
Why would a firm be willing to risk its capital on an unknown trader?
Investing is only smart if the investment has a quantifiably high chance of success. That being said, how can these prop firms confidently provide funded trading accounts to unknown traders? This is where the challenge model of prop trading comes in.
To become a funded trader, you must demonstrate the ability to trade profitably and efficiently. To verify this, the prop firm issues a trading challenge, and only the traders who meet the challenge with success go on to receive funding. To be evaluated, traders must register to the challenge for a fee that is proportional to the account size they wish to eventually obtain.
Challenge types, rules, and pricing
Prop firm Ultimate Traders serves as a good illustration of how the prop trading process typically works. Their funded trading accounts range from $10,000 up to $400,000. To receive these accounts, they give traders the option between two types of challenge; the Classic Challenge (which evaluates the trader over two phases of trading) and the Speedy Challenge (which evaluates the trader over just one phase of trading). The cost of the Classic Challenge for the smallest account size is $99 whilst for the largest is $1799.
In both challenges, the primary objective is to grow the starting balance of a simulated trading account by a given percentage. Whilst attempting this, the trader must not exceed drawdown limits stipulated by the firm. The reason behind including drawdown limits is to ensure that profits are achieved in a conscious and controlled manner, rather than via lottery.
There are two types of drawdowns to be wary of – the daily drawdown and the max drawdown. The daily drawdown is the loss amount the trader should not exceed in a single day, based on the equity that is recorded every 24 hours. The max drawdown is a baseline floor which the equity must never fall below, based on the starting balance of the account. The account balance itself is equal to the balance of the funded account that the trader is being evaluated for.
The default profit share for all prop traders who receive funding from Ultimate Traders is 80% trader, 20% firm. Ultimate Traders also has the option for the trader to receive 90% in exchange for a one-time premium on the registration fee.
Who hosts the accounts?
Every prop trading firm liaises with a regular retail broker who provides trading accounts. For example, Ultimate Traders uses T4Trade as their host broker, and both challenge and funded trading accounts use the same live MT4 servers provided to the broker’s retail traders. This ensures objective market pricing. Available instruments include forex, commodities, indices, and cryptos
So, should you trade or prop-trade?
Returning to the original question, should traders aim high with a prop firm, or are they better off sticking with their regular broker?
The obvious attraction in proprietary trading is the potential to achieve significantly higher profits without risking personal capital every time a new position is opened. The risk in prop trading lies in the evaluation since trading the firm’s funds is contingent on passing it. However, when objectively considering the alternative of using the registration fee to self-fund, the likelihood of achieving substantial gains is minimal.
Professional traders typically target an annual return on investment (ROI) of 10-20%. So even if the $1,799 fee (required for a $400,000 Ultimate Traders account) is directly invested into retail trading, a successful year following risk-averse strategies might yield around $350. This modest return is unlikely to motivate most traders. Consequently, what often occurs with under-funded traders is risk-taking that resembles gambling more than it does trading. The truth about self-funded trading is that only a minority of traders are adequately funded for it to be worthwhile.
Given the scale of the funded trading accounts available, those with a refined trading strategy but an absence of serious capital may be better off paying the one-time registration fee to be evaluated by Ultimate Traders. In other words, if you have the skills of a pro trader, but not the bankroll, then prop trading should certainly be considered.