Basics of Prop Firms Explained

If you’ve been looking into trading, you’ve probably heard of prop firms. But what exactly are they, and how do they work? Look, whether you're an expert trader or just starting out, understanding prop firms can be a game-changer for your trading journey. So in the next couple minutes, we’re going to deep dive into the basics of prop firms, how they operate, and why they might be the most important part of trading you’ve never learned about.

Introduction to Prop Trading Firms

What is a Prop Firm?

Proprietary trading firms, or prop firms for short, are companies that give traders large capital to trade with so traders can make more profit without risking their own hard earned dollars. In return for this capital, the firms take a cut of the profits. Sounds like a win-win, right? You get access to big trading capital without risking your own money, and the firm gets a slice of the profits you generate.

History and Evolution of Prop Firms

Prop trading has been around for decades. It was originally dominated by big banks and financial institutions. However, as technology advanced, the opportunities became more available to the average trader. High-speed internet, advanced trading platforms, and algorithmic trading opened the doors for independent prop firms that fund traders like you to emerge.

How Does a Prop Firm Work

So, how do prop firms actually function? At the core, prop firms make money by sharing profits with their traders. Here’s a simple breakdown: the firm gives you capital, you trade using that capital, and any profits that you make are split between you and the firm. The profit split can vary by firm, but it’s not uncommon for traders to keep anywhere from 70% to 90% of their profits. It’s a partnership that puts the interests of both parties in a mutually beneficial state – the better you perform, the more everyone benefits.

The Prop Trading Model

The whole model or idea of prop trading revolves around giving talented traders access to capital. It’s all about performance. Unlike traditional hedge funds where investors’ money is managed, prop firms use their own funds, making them more aggressive and risk-tolerant. The firms offer different types and sizes of accounts, each with its own rules, funding levels, and profit splits. Usually, firms have an evaluation process that traders must pass initially. Then after they pass, they are funded and can start trading live capital.

Evaluation and Funding Process

Now, of course, a prop firm won’t just hand over capital without some due diligence. There’s usually an evaluation process that traders must go through. This might involve simulated trading challenges, profit targets, and risk management rules. Think of it as a tryout – the firm wants to see if you’ve got what it takes before giving you a shot. For example, some firms use a two-step evaluation process where you need to hit 2 specific profit targets without hitting your drawdown limits. It’s all about showing you can manage risk and make consistent gains.

Key Features of Prop Firms

Every prop firm has its own unique features or selling points. However there are some commonalities that traders should look out for:

Account Types and Funding Options

Prop firms typically offer a variety of account types to cater to different trading styles and experience levels. There are evaluation accounts that require traders to prove themselves through multiple stages, as well as instant funding options for seasoned pros which are typically more expensive. To make it simple, there are options for practically every type of trader. In fact, some firms even offer scaling plans where proven traders can gradually get access to larger sums of capital as they hit performance milestones. That means you could start with just $50,000 and, over time, scale up to $500,000 as you prove your worth.

Profit Splits and Payouts

Profit sharing is the main benefit of prop trading. Different firms offer different splits, and it’s a critical factor when choosing a firm. Some firms let traders keep up to 90% of their profits, while others might offer a smaller slice but with added perks like instant payouts or no evaluation fees. Understanding the payout structure is key – after all, you want to make sure your hard-earned profits don’t get caught up in legal jargon or contractual terms. 

Trading Platforms and Tools

A good prop firm offers practical, up-to-date, modern trading platforms and tools. Some of the most popular platforms are MetaTrader 4 (MT4) and MetaTrader 5 (MT5), known for their advanced charting tools, ease of use, EA’s, and other features. Some firms might also provide additional software, data feeds, or even trading bots to give you that extra edge. The bottom line? The better the tools, the more equipped you'll be to tackle the markets.

Types of Prop Trading Firms

However, not all prop firms are created equal. Depending on what assets you want to trade, different firms might be better for you. Here’s a quick breakdown:

Forex Prop Firms

Forex prop firms specialize in currency trading. They offer various account types and usually have specific rules tailored to the Forex market. These firms are great if you’re a Forex trader. The Forex market’s 24-hour nature and high liquidity make it a popular choice for prop trading.

Multi-Asset Prop Firms

If you prefer trading across multiple asset classes – like stocks, indices, commodities, or even crypto – multi-asset prop firms might be the way to go. They offer a broader range of trading instruments, allowing you as a trader to choose different instruments and strategies based on what you perform best with. 

Criteria for Choosing the Right Prop Firm

Picking the right prop firm can feel like a daunting task. With so many options, where do you start? Here are some critical factors to consider:

Regulatory Compliance and Reputation

A firm’s reputation is everything. Look for firms that are transparent, regulated, and have good reviews from traders. Checking platforms like Trustpilot or our reviews page here on propfirmmatch.com can give you a sense of how the firm operates. Does it pay out on time? Is the support team helpful? Red flags like poor communication or unrealistic promises should make you think twice.

Risk Management Policies

Risk management is crucial in trading, and prop firms usually have strict rules in place to protect their capital. This could include daily loss limits, maximum drawdown, or restrictions on trading during high-impact news events. You need to understand these policies to make sure you avoid costly mistakes and align your trading with the firm’s expectations.

Support and Educational Resources

Some firms go the extra mile and offer educational resources, training programs, or even one-on-one mentorship. This is a game-changer and can be incredibly valuable, especially if you’re still learning to trade. The best firms don’t just give you money to trade; they invest in your success by providing the tools and knowledge you need to thrive.

Pros and Cons of Joining a Prop Firm

Like anything in life, prop trading comes with its pros and cons. Let’s break them down:

Advantages

• Access to Capital: One of the biggest draws for prop firms is the massive amount of capital you can access to multiply your reward while keeping your risk low. 
• Reduced Financial Risk: Since you’re trading the firm’s money, your personal financial risk is significantly reduced. This can take a lot of the pressure off and allow you to focus on executing your strategy.
• Professional Environment: Prop firms often provide a professional trading environment, complete with advanced platforms, data feeds, and a supportive community.

Disadvantages

• High Pressure: Trading with someone else’s money can be stressful, especially when there are strict rules and performance targets to hit.
• Limited Flexibility: Some firms put restrictions on some trading styles. This might impact the way you trade and your personal approach. This is why you must check a firm’s policies before committing. 

Top Prop Trading Firms in 2024

Let’s take a look at some of the top prop firms in 2024:

Funded Trading Plus

With a Trustpilot rating of 4.9, Funded Trading Plus is a favorite among traders. They offer a two-step evaluation process, generous profit splits, and access to a wide range of trading instruments.

Blue Guardian

Blue Guardian is based in the UAE and has quickly built a strong reputation with a 4.8 Trustpilot rating. They offer competitive profit splits, robust support, and a variety of account types, making them an attractive option for traders of all levels.

The 5%ers

The 5%ers operate out of Israel. They offer an 80% profit split on their 100K 2-step account plan. They support trading across Forex, Metals, Indices, Crypto, and Commodities, so you’ll have a lot of options to explore. 

Funding Pips

Another UAE-based firm is Funding Pips. They boast an 80% profit split and fast payouts within 5 days. They support trading on MT5 and offer access to Forex, Crypto, Indices, Metals, and Energies – perfect for those who love trading variety.

Strategies for Success in Prop Trading

We can’t give you a trading strategy, but here are some general guidelines for success in your prop trading career.

Aligning with Firm Rules and Guidelines

Every firm has its own set of rules, and understanding these is key to your success. Some may have higher or lower daily loss limits which could lead to disaster if you don’t read them properly. Some may now allow news trading. Rules like this may force you out of a well-deserved payout, so watch out for the firm’s rules and ensure you read them thoroughly. 

Developing a Strong Trading Strategy

Having a solid trading strategy is crucial. Whether you’re into scalping, swing trading, or algo trading, make sure your strategy is in alignment with the firm’s guidelines.

Sticking to Risk Management Principles

Risk management isn’t just a buzzword; it’s your safety net. You need to be sizing properly in your positions, setting stop losses, and avoid overtrading. Creating bad habits that consist of these can ruin you. That’s why building good habits around these topics is essential to your trading success. 

Leveraging Educational Resources

As mentioned before, many top prop firms offer educational resources. Some do webinars as well as one-on-one coaching sessions. Topstep even offers their ‘TopstepTV’ program which is similar to a news program for traders which can help in great amounts. Don’t underestimate the value of continuous learning. Staying updated with market trends, refining your strategy, and learning from experienced traders can give you a massive edge.

Conclusion

Prop firms are a powerful tool for traders. They allow traders to access large capital and earn massive profits while minimizing the risk they create for themself. The firms can allow them to trade a wide array of assets. While the road to becoming a successful prop trader isn’t without its challenges, the potential rewards make it a compelling option for traders looking to take their skills to the next level. By choosing the right firm, aligning with their rules, and applying strong trading principles, you can turn the opportunity into a lucrative venture.

FAQs

1. What is a prop firm? A Prop firm is a company that provides traders with capital to trade financial markets, sharing the profits made from successful trades.

2. How do prop firms make money? Prop firms make money by taking a portion of the profits generated by traders who use the firm’s capital.

3. What is a profit split? A profit split is the percentage of profits that a trader keeps, with the remainder going to the prop firm.

4. Are prop firms regulated? Regulation varies by firm and location. It's crucial to check each firm's regulatory status before signing up.

5. What assets can I trade with a prop firm? Depending on the firm, traders can access a variety of assets including Forex, stocks, indices, commodities, and cryptocurrencies.

6. How do I get funded by a prop firm? Most prop firms require traders to pass an evaluation process to prove their trading skills before providing funding.

7. What is drawdown in prop trading? Drawdown refers to the decline from a trader's peak balance to the lowest point before a new high. Firms usually set limits to control risk.

8. Can beginners join prop firms? While many firms welcome beginners, it's essential for new traders to thoroughly understand the firm's rules and requirements to avoid pitfalls.