How finding the right prop firm could turbo charge your gains

Trading with proprietary trading firm (or prop firm for short) presents the advantage of potentially yielding higher returns due to the increased trading capital, enabling a better profit margin while mitigating risks.

But, new traders interested in funded trading accounts face a daunting task of selecting the appropriate prop firm from a vast array of available options. In simple terms, a prop firm is a company that supplies traders with trading capital, taking a percentage of the profits based on predetermined terms and conditions.

However, numerous traders often overlook the necessity of thoroughly examining the requirements for successfully managing a prop firm account. This oversight frequently leads to the loss of their account shortly after obtaining it. Given the abundance of companies offering seemingly attractive deals and advantages, making an informed decision becomes challenging. Conducting comprehensive research before committing to a particular firm becomes crucial.

In this article, we delve into the most important factors to consider when selecting a prop firm.

How do funded trading accounts work?

The initial step towards becoming a funded trader involves paying a deposit to be assessed in an evaluation "challenge". For example, a prop firm might require a trader to pay a $500 deposit and achieve 8% returns while maintaining a maximum 8% drawdown over a period of 60 days.

Upon successfully meeting the challenge’s requirements, the trader receives his deposit back along with an account funded with $100k. At this point, the trader must adhere to the same risk management parameters established in the challenge. Any realised gains thereafter are divided between the trader and the prop firm. The exact profit sharing arrangement for funded trader accounts varies across firms, ranging from a 50/50 split to a 90/10 split favouring the trader. There are usually three ways a trader can fail a challenge or lose his account:

1. Suffering a drawdown over the maximum drawdown limit dictated by the terms and conditions;

2. A daily drawdown over the maximum allowable daily drawdown limit;

3. Failing to reach the profit target level within the specified time limit;

The pros of prop trading

In principle, there are many advantages to prop trading, with the main ones being the following:

1. Prop trading provides an opportunity to earn substantial profits without making significant upfront investments. This is ideal for traders with genuine edges but limited funds, who can access substantial capital within a relatively short span of time. The cost of participating in and passing an evaluation challenge is often only a few hundred dollars, but traders can subsequently make several thousand dollars in the following months.

2. As the majority of risk is borne by the prop trading firm, prop traders only risk the initial investment in the program. Any losses incurred beyond that point are absorbed by the firm.

3. Following from the previous point, since the real risk is capped at the initial evaluation challenge fee, traders can trade larger sums with far less psychological toll.

4. Many prop trading firms offer well-designed progression systems that enable traders to scale their assets under management by reaching realistic targets, thereby increasing their monthly income progressively.

What’s the catch?

The pros of prop trading listed above seem to paint a really good picture. Sceptics would say it seems too good to be true. The reality is that typically, less than 5% of applicants succeed in passing evaluation challenges. Although these statistics may appear disheartening, we must recognize that they are deliberately established as such. Prop firms seek traders who can consistently generate profitable trades while minimising risk, hence the high standards they have set. So prop trading is only advisable if you have one or multiple strategies founded on true edges and have mastered solid risk management.

Beyond the difficulty of adhering to the risk management guidelines, there are two chief concerns about how prop firms operate. The first lies in their business model. Prop firms make money in two ways: firstly through fees from failed challenges and secondly through a percentage of the realised capital gains. In the case of prop firms relying mostly on failed challenges to turn a profit, there may be a short-term motivation to increase the difficulty of their challenges by introducing undisclosed rules or unfavourable trading conditions. This strategy aims to raise the failure rate, resulting in fewer evaluation fee refunds and, consequently, higher net revenue for the firms.

This and other nefarious practices are only exacerbated by a low amount of regulation to protect funded traders. The issue of prop firms lacking regulation stems from the fact that they handle their own funds rather than someone else’s. Furthermore, certain prop firms only offer traders access to virtual capital even after successfully completing an evaluation and gaining entry to a "live" account. Consequently, no actual financial transactions occur in these cases. Prop firms often position themselves as providers of "financial education" to avoid regulations and scrutiny.

Although the absence of regulations may simplify and reduce costs associated with obtaining funding from prop firms, it also means that traders have limited safeguards and are largely on their own in determining which prop firms to trust. The lack of supervision and accountability exposes traders to potential risks such as fraud and other forms of misconduct.

How should you choose prop firms?

Finding a reputable prop firm

As implied from the previous sections, although prop firms are generally not scams, it is important to be aware that scammers can impersonate prop firms. Therefore, it is crucial to differentiate between reputable and fraudulent prop firms.

A prop firm’s reputation can be assessed in various ways. For example, checking their ratings and reviews on social media can provide insights into their performance, advantages, and disadvantages. Additionally, visiting forums where individuals share their experiences with different prop firms can be valuable. Whenever possible, it is advisable to speak directly to someone who’s traded with the firm to ensure the firm actually pays their traders on time and treats them fairly. Generally speaking, it is safest to stick with prop firms that have been operating for many years with a substantial online presence and many testimonials.

Another sign of a reputable firm lies in excellent support services. Knowing that you can rely on their assistance whenever needed can bring peace of mind. Therefore, it is important to verify that the prop firm provides round-the-clock support and ensures easy accessibility and prompt responses. To test the waters, it may be worth contacting customer service directly to get a sense of the firm’s professionalism.

Lastly, there are three ways of discerning a firm’s genuine motive in seeking successful traders rather than relying on retained fees from failed challenges:

1. When considering a prop firm to trade with, pay attention to the profit split they offer. A profit split around 50% suggests they earn from profitable traders. However, new firms offering a 100% profit split indicate they don't profit from successful traders. Instead, they literally rely on you failing. It may sound counterintuitive to prefer a prop firm with profit splits that are on paper disadvantageous to traders. But it’s a clear statement of intent of where the firms’ interests lie, and the importance of this cannot be overstated;

2. Prop firms that provide instant funding (no evaluation challenge) often operate on a pyramid scheme-like business model. Offering capital to traders without assessing their trading abilities or metrics doesn't align with sound business practices. These prop firms tend to offer demo capital rather than actual trading funds. When trading on a demo account, the prop firm doesn't profit from your successful trades. Instead, your payouts come from other traders who fail their trading challenges and lose money. This similarity to a pyramid scheme raises concerns. It is not sustainable and is likely only a matter of time before regulatory bodies take notice.

3. The more educational content a firm provides, the more likely they’re interested in maximising the success rate of applicants;

In addition, to steer clear of potential scams associated with prop trading firms, it is crucial to remain vigilant and pay attention to the following indicators:

• Limited reviews on Trustpilot and similar websites;

• Promises of quick wealth accompanied by an excessive number of rules designed to make traders fail;

• Unprofessional website design, subpar user experience, and noticeable spelling errors;

• Little to no presence on popular social media platforms or evidence of payout proof;

• Scarcity of information about the company available online;

• Unresponsive customer service.

• Not featured on any lists of best prop trading firms

Desirable funded-account rules

Once a qualitative assessment of a firm’s reputation has been completed, there are several other factors traders should be mindful of to make an informed decision that will best suit them. These include the following:

• Ensure the prop firm in question is compatible with your trading style. For example, most prop firms won’t allow you to hold positions over the weekend. So if you’re a swing trader and typically hold positions over the weekend, you’ll either have to adjust your strategies or look for a prop firm with terms and conditions that suit you;

• Whatever your trading instrument of choice, check whether it is allowed by the prop firm. For instance, many prop firms only allow trading of currency pairs and will be irrelevant to you if say, you mainly trade cryptocurrencies;

• To minimise the chances of failing a challenge, select a prop firm that doesn’t set a time limit to reach the target profit. Luckily, with the increasing competition between online prop firms, this is now starting to become the new norm;

• Choose a firm with a static or fixed maximum drawdown requirement and not a trailing one. Trailing maximum drawdown rules are difficult to adhere to in the long run and make accounts less scalable.

• To assess the difficulty of the evaluation challenge, a useful metric to use is the maximum allowable drawdown divided by the profit target level. The higher this metric, the more difficult it is to pass the challenge. As a rule of thumb, a value of 1 for this ratio is considered good.

• Prioritise prop firms with attractive scaling opportunities. That is, lend preference to firms with clear plans laid out for you to trade increasingly more capital as you continue to meet profit targets;

Choose a prop firm offering affordable trading accounts.The maximum drawdown allowed multiplied by the initial account size tells you how much you can afford to lose before your account is removed. So, for all intensive purposes, this is the true sum of money the prop firm is backing you with. Affordability can be gauged by dividing this value by the initial challenge fee.

Other considerations to minimise risk

It is highly advisable to not trade exclusively with one prop firm. Seasoned traders recommend joining multiple reputable prop firms to diversify your risk. If one firm encounters issues, you won't lose all your funds. Additionally, you can trade both on your personal account and with prop firms simultaneously. Many successful prop traders will recommend following this strategy:

1. Use your personal account as your main account funded with your own capital;

2. Trade with at least two prop firms;

3. Withdraw monthly from prop firm accounts to safeguard funds and add them to your personal account for growth.

This way, you minimise risk and gradually build your personal capital until you can trade independently without relying on prop firms.

Conclusion

In conclusion, prop trading presents traders with a legitimate way of scaling their accounts very quickly. Nevertheless, it is important to acknowledge that becoming a prop trader demands diligent effort, unwavering commitment, and exceptional risk management abilities. It is vital to conduct comprehensive research and carefully select a reputable prop trading firm with transparent rules that align with your objectives and strategies. Prop firms should only be considered once you have a strategy you have proven can generate consistent returns. This is a hard lesson many inexperienced traders will learn when they lose their deposits.

The journey to becoming a successful prop trader can be demanding, but with the appropriate mindset, approach, and strategies, it can also be an immensely fulfilling and rewarding endeavour.