Prop Trading vs Traditional Trading

(MENAFN- Digital solutions)

Proprietary trading is a new trend that has become popular in the financial market over the last two years because it offers a unique way for traders to access funds and markets. Traders and casual investors have two paths in the financial markets: retail and prop trading. Each method has individual merits and operational structures.

What is Prop Trading

Prop trading is when banks and financial firms trade financial instruments like stocks, bonds, commodities, currencies, and derivatives using their capital rather than trading with clients’ funds. Prop trading allows these prop firms to offer professional and retail traders the opportunity to trade without using their own money and receive a share of whatever profits they make. For example, the OANDA Prop Trader, launched in January 2024, is a prop firm helping improve access to financial markets. This approach benefits prop firms and traders, allowing prop providers to access a broader pool of traders and removing the burden of associated risks from traders.

Comparing Prop Trading vs Traditional Trading

We’ll explore how prop trading compares to traditional trading, its benefits, the instruments traders can explore, and the requirements to become a prop trader.

How It Works

In proprietary trading, the firm provides capital to traders, allowing them to execute trades and receive compensation for their performance. The compensation typically follows a profit-share agreement. Prop firms can offer the product using their broker (such as OANDA does) and collaborate with other trading platforms (TradingView, MetaTrader4, MetaTrader 5, cTrader, etc).

The capital prop firms make available is usually from a hedge fund or brokerage firm, and the trades must comply with the specific rules of the brokers. Prop firms also offer virtual capital, which traders use to execute trades. The trade signals are sent and executed on live trading accounts. Prop traders are generally required to undergo verification, which is a challenging process for assessing their trading skills. This is necessary to limit the exposure as traders are exposed to live market conditions.

In retail trading, no funds are allocated to traders. Instead, they deposit and use the capital to execute trades based on their rules. Although brokers set market conditions, such as margins and spreads, retail traders have more flexibility when trading but are more exposed to market factors.

Trading Rules

Retail traders must comply with the broker conditions, such as margins and spreads, but they can make most decisions themselves. Prop traders also enjoy freedom when trading but must stay within drawdown limits, meet a minimum number of trading days, and meet other conditions the prop firm might require. There are usually penalties for breaching prop firm rules; most prop firms terminate the challenge if traders breach rules. Some prop firms permit news trading while others do not.

Fees and Commissions

Brokers may charge trading fees and commissions, ranging from platform fees to inactivity or overnight trading commissions. Prop firms now offer no-commission fee trades for some instruments and competitive platform fees. The significant fees that prop firms charge are for challenge accounts. Prop traders pay an initial fee to take challenges and usually receive a refund upon completion. Some prop firms charge a cost-to-day fee, which is factored into the trading commission, where applicable.

Finally, prop traders are charged a portion of their profits. This is a form of compensation to the prop firm, which provides the capital and ensures traders do not bear specific responsibilities. On the other hand, retail traders are not charged any part of their profits but may pay commissions for overnight trading.

Benefits for Brokers and Traders

Prop traders enjoy three main benefits:

1. Larger Capital — Most prop firms offer a minimum of $5000 and up to $5 million in trading capital. This allows their traders to use larger lot sizes than retail traders within risk management rules. Larger capital also increases the profit potential. For instance, a prop trader hitting 0.5% in profits on a $1 million account and eligible for a 90% profit share would earn $4500.
2. Training and Support — Prop firms are motivated to train traders, so they offer advanced trading classes, webinars, market analysis, and technological support to help traders maximize their trades.
3. Reduced Risks — Prop firms significantly lower the financial exposure and stress associated with trading drawdowns, as traders do not use their capital.

Additional benefits include:

1. Access to Talented Traders — The assessment process ensures that only skilled traders can access prop capital. Attracting skilled trades can enhance the overall trading performance of prop firms.
2. Increased Clients — Prop firms that offer brokerage services also benefit from having more traders sign up via their broker, which can contribute to their goals and objectives.
3. Advanced Technologies and Partnerships — Prop firms and the brokers they use must adopt modern technologies to offer effective services. These improve their infrastructure and market capacity.
4. Regulatory Flexibility — Specific regulations do not encumber prop firms because they do not hold traders' funds, which allows them to offer their services more effectively.

Trading Instruments

Most prop firms allow traders to explore a variety of financial instruments, such as forex pairs, shares, options, futures, commodities, and contracts for difference (CFDs). Some also offer cryptocurrency trading and derivatives. Traders gain access to tools like sentiment, topical instruments, currency strength, currency power balance, volatility chart, correlation tool, and value at risk tool, as well as advanced tools on third-party trading platforms like MT5.

Becoming a Prop Trader

Traders require three things to become prop traders:

1. Excellent trading skills and the confidence to analyze and trade financial markets.
2. An initial fund to purchase challenge accounts.
3. A trading plan with well-defined risk management.

The first step is to visit the website of the prop firm and purchase a challenge account. Identity verification is necessary to complete the setup process. Traders can then explore trading with the prop firm.

How To Choose Between Prop Trading and Traditional Trading

Both prop and traditional trading have advantages that would make them a better choice depending on what a trader is looking for in terms of goals, risk tolerance, and skill. Prop trading gives access to larger capital and less personal financial risk, along with professional support; retail trading provides more flexibility and control over trading decisions. It all comes down to what fits one’s style as a trader and long-term goals. Whether you value the structured environment that prop firms offer or the independence found in retail trading, being aware of both paths can assist in making the right decision.

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