How to start a prop trading firm

Starting a prop trading firm —also known as proprietary trading— can prove to be a lucrative business for those with a keen understanding of financial markets and a knack for innovative trading strategies. Unlike traditional investment firms that trade with client assets, prop trading firms use their own capital to increase their wealth. Given that this model allows firms to keep all profits made from their trading ventures, it encourages in-depth investigation and rigorous risk management. Following a tightening of CFD trading regulations by the European Securities and Markets Authority’s (ESMA), the prop trade industry welcomed numerous FX and CFD brokers that added prop trading to their business model, or that switched strategies altogether, due to the lighter regulatory scrutiny. 

This article takes a closer look at how to start a prop trading firm, or add a prop trading department to your current business model. 

What is a prop trading firm?

Firms that engage in prop trading —or, as mentioned above, proprietary trading— use their own capital to trade a variety of financial assets, such as securities, equities, derivatives, forex, and futures, for direct profit. Instead of earning a commission on trades they make for their clients, prop trading firms reap all financial rewards from their successes, which either goes back into the firm or is divided among employees. This model can involve several different financial strategies, such as hedging risks to speculative trading. In this way, prop firms contribute significantly to market liquidity and efficiency by engaging in large trading volumes across both exchange and over-the-counter markets. Many prop trading firms are independent businesses that exclusively use their own capital. Others form part of a larger brokerage, and could have access to insights into market movements. 

How to learn more about prop trading

The best way to learn the ins and outs of prop trading is to work for a prop trading firm. It is essential to have ample experience trading, and to be able to demonstrate a successful trajectory, but a willingness to learn and develop one’s skills is often a desirable trait in candidates. Traders are often selected due to their ability to demonstrate they have been able to make a profit in diversified market conditions, and apply systematic risk management strategies, such as stop-loss orders, to minimize losses. 

After passing an initial assessment, a prop trader’s contracts tend to outline their profit share, which varies depending on the firm, and their trading capital, which may also change depending on the trader’s performance. Once part of a firm, traders often benefit from a host of resources and educational support in order to hone their skills and ultimately amplify profits. Access to advanced technological tools and trading software also tends to be standard, providing real-time data and analysis programs that can help identify opportunities, as is coaching and access to mentorship programs, which opens the door to learning from more experienced team members. 

Aside from hands-on experience, webinars and live demonstrations offer excellent learning opportunities and the chance to ask questions to seasoned prop traders. Another option is self-study through online courses, allowing keen traders to learn the ropes at their own pace.

How to start a prop trading firm

Traders with ample experience working for a prop trading firm, or as part of a prop trading department, may choose to step out on their own and start their own business. As with any new venture, this decision requires careful consideration and a detailed business plan that outlines the kind instruments they wish to focus on. Stock and options prop trading firms are often the most accessible for beginners, while futures prop trading firms are more prevalent. There are also a lot of prop trading firms that focus on forex, so many in fact that the market is bordering on saturation. 

It will also be necessary to outline the kind of technology needed, how much it will cost, whether more staff members are needed for marketing or accounting, and whether the firm will need a physical space in which to operate, which further adds to overhead expenses. Regarding licenses and regulatory compliance, traders in the US are only able to offer prop trading of exchange-traded securities —CFD trading is prohibited— which requires a license from the SEC and the FINRA. 

A new prop trading firm’s profitability hinges on attracting and retaining clients, and managing risk exposure through advanced trading technology. This might take the form of real-time exposure monitoring and software that sets maximum drawdowns, which can help keep traders within imposed risk exposure limits and protect assets. A strong marketing approach with clear branding and engaging activities such as active social media accounts, webinars and trading contests will also help to attain and retain clients and boost confidence in the firm’s reputation. 

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