What is Prop Trading and How Does it Work?

Proprietary ("prop") trading is a financial practice in which a firm trades financial instruments with its own capital rather than using clients' money. In other words, a prop trading company (or a bank's prop desk) plays the market for itself – effectively acting as its own investor. For example, Investopedia explains that prop trading occurs when a trading desk at a financial institution or brokerage "uses the firm's capital and balance sheet to conduct self-promoting financial transactions".

This means any gains and losses directly affect the firm's balance sheet, aligning the firm's success with market performance. Prop firms "trade with their own capital", as Nasdaq notes, giving them a full stake in any profits while requiring strict risk controls.

Also called proprietary trading, prop trading can encompass stocks, bonds, forex, commodities, derivatives or cryptocurrencies – virtually any marketable asset. Traders at prop firms – sometimes called prop traders – use sophisticated strategies such as arbitrage, technical analysis, quantitative models or global macro trading to try to profit from market movements. In effect, prop traders often function like in-house hedge funds, taking calculated positions to boost the firm's revenues. It is important to note that unlike mutual fund or advisory models, prop firms generate income from trading profits (not commissions), so they keep 100% of gains but also bear all the losses.

Overview: Prop Trading

Know How Prop Trading Works

Prop trading firms operate by providing traders with capital and resources in exchange for sharing profits. In practice, a prop firm typically designs an evaluation or "challenge" process. Aspiring traders must demonstrate skill and discipline under simulated or live conditions, hitting profit targets and adhering to risk rules. For example, traders might need to achieve a set profit (e.g. 10%) on a demo account without exceeding daily or total drawdown limits. PropAccount explains that these firms "give access to the firm's capital so that traders can take bigger positions with more capital" than their own money, sharing in gains. In turn, "prop trading firms attract the best traders by offering funded accounts, superior trading platforms, and structured profit-sharing models". In other words, the firm provides the financial muscle – while the trader provides the strategy.

Once a trader passes the evaluation, they receive a funded account. This account often comes with strict risk management rules: daily loss limits, overall drawdown caps, and minimum or maximum trade sizes. For instance, many prop firms require traders to limit any single trade risk to a small percentage of the account. The aim is to protect the firm's capital. Some prop programs even enforce a minimum number of trading days to demonstrate consistency. FTMO – a well-known prop firm – historically required at least 4 trading days during its evaluation, ensuring that a trader's profit was not due to a single lucky trade. (Notably, once funded, FTMO currently removes any minimum days rule) Such rules ensure that profits are earned steadily and risks are managed. Breaking any rule usually means losing the funded account.

It is important to note that prop trading is not free money. The firm's capital and advanced trading software come at a cost. Traders often pay an initial fee or monthly subscription for the evaluation, and profits are shared (for example, a trader might keep 70–80% of gains, with the firm taking the rest). The benefit is access to leverage and resources: experienced traders may trade positions many times larger than they could on personal funds, with no debt incurred. In effect, prop firms offer "leverage without debt" – traders amplify gains by using the firm's money, but without a traditional loan obligation. Metaphorically, joining a prop firm is like putting a high-octane engine under your trading: you have more horsepower to race with, as long as you steer carefully and obey the rules.

Prop Firms and Prop Desks

Historically, large banks had in-house prop trading units known as prop desks, where bank employees would trade the bank's capital. These desks often operated like internal hedge funds. For example, The Guardian described bank prop desk traders as specialists betting on share prices, derivatives or any traded assets. However, regulatory reforms have changed this dramatically. In the United States, the Volcker Rule (part of the 2010 Dodd-Frank Act) banned traditional banks from most proprietary trading.

"Congress has spoken…There is going to be a change in the banking industry"

As a result, many banks spun off or closed their prop desks, and the proprietary trading scene is now dominated by independent firms and hedge funds.

Today's prop trading firms are usually standalone companies (or divisions) that raise outside capital or use investors' money to fund traders. Unlike banks, these firms exist solely to execute trading strategies. Some are small boutique firms; others are large, multi-strategy firms. Many specialize in one market (like forex or futures), while others trade equities or crypto across global markets. A few notable proprietary trading firms include Jane Street, Citadel Securities, Jump Trading, DRW, Optiver and Hudson River Trading– some of the biggest names in trading. These companies are often profitable market makers or high-frequency trading houses.

On the other hand, newer online prop firms like FTMO, Topstep (for futures), and TradersYard focus on retail traders: they sell structured evaluation programs and funding for individual day traders.

As has been discussed earlier, prop trading firms contribute to market liquidity and efficiency. By actively trading, they help fill both sides of orders in less-liquid situations. Many firms also provide educational and community support. For example, Nasdaq reports that new traders join prop firms for "access to more significant capital and advanced trading technologies. Support networks within these firms often include training, mentorship, and a community of traders, providing valuable resources for professional development". In short, modern prop firms combine the high-stakes trading of Wall Street with the resources and structure needed to train talented traders.

Types of Prop Trading Strategies

Proprietary trading firms use a variety of advanced strategies to generate profits from market movements. These strategies are typically data-driven, technology-enabled, and designed to capitalize on both short-term and long-term opportunities. One common approach is scalping, which involves making a large number of quick trades to capture small price movements.

Scalpers thrive in highly liquid markets and rely on speed and precision. Another widely used strategy is arbitrage, where traders exploit price discrepancies between different markets or instruments to earn risk-free profits. Algorithmic trading is also a dominant method in prop trading. This involves the use of computer programs to execute trades based on pre-defined rules, often incorporating real-time market data and technical indicators.

High-Frequency Trading (HFT) is a specialized subset of algorithmic trading that focuses on executing thousands of trades in milliseconds. It requires ultra-low-latency infrastructure and is commonly used by large firms with robust technological resources.

Swing trading, on the other hand, targets medium-term price movements and typically holds positions for several days or weeks. Some prop traders also engage in news-based trading, where trades are executed based on macroeconomic announcements, earnings releases, or geopolitical developments.

Each strategy has its own risk profile and capital requirement, and prop traders often specialize in one or two methods based on their skill set, the firm's infrastructure, and market conditions.

Regulation of Prop Trading

Regulation of proprietary trading varies significantly across jurisdictions and has evolved in response to financial crises and the growing complexity of global markets. In the United States, one of the most impactful regulatory measures was the Volcker Rule, introduced as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The Volcker Rule restricts commercial banks from engaging in prop trading with their own accounts, aiming to reduce systemic risk and protect depositors' funds. While it doesn't ban all proprietary trading, it draws a clear line between client-focused services and speculative trading activities.

In other parts of the world, such as the European Union, regulators have imposed their own frameworks under legislation like MiFID II, which increases transparency and accountability for trading firms. In countries like India, Singapore, and Australia, proprietary trading is legal but subject to strict oversight by financial regulators such as SEBI, MAS, and ASIC respectively. Most regulations focus on capital adequacy, risk controls, and disclosure requirements.

Independent prop firms—those that do not take public deposits—generally have more freedom in their trading activities but must still adhere to financial reporting standards and anti-money laundering (AML) compliance. As markets continue to evolve and technology advances, regulatory scrutiny is expected to intensify, pushing firms toward greater transparency and risk management discipline.

Benefits and Risks

In many ways, prop trading can accelerate a trader's career. Because traders use the firm's capital, they significantly reduce personal financial risk. In the words of industry sources, trading with a prop firm "significantly reduces traders' financial risk since they use the firm's capital rather than their own money". This cushion often allows traders to focus on strategy rather than worrying about personal losses.

Firms also offer technology (professional-grade platforms, market data and even AI risk tools) that would be costly for an individual to obtain. In exchange, the trader gains leverage – they can control much larger positions. As GoatFundedTrader notes, prop firms "supply traders with access to funded accounts, allowing them to take bigger positions than they could on their own". This leverage is "distinct from borrowing" – it is effectively equity investment from the firm, not a loan.

However, prop trading is not without challenges. The rules are strict and mistakes are punished immediately – a single large loss can wipe out a funded account. James Glyde, CEO of PipFarm (a prop trading community), cautions that "the risk is incredibly hard to manage in the prop trading industry… it is assumed the traders will lose". In other words, prop firms structure their programs knowing most traders will fail the evaluation.

Only disciplined risk management and consistency allow a trader to survive. It is important to note that industry dynamics have been volatile: in 2024 a wave of prop firms closed. FPFX CEO Justin Hertzberg warned investors that "many more prop firms [are expected] to close, cease or halt operations" amid technological and regulatory shifts. This consolidation reflects the fact that the prop trading business can be a high-pressure, competitive arena.

Conclusion

Conclusively, proprietary trading offers traders an avenue to trade with much larger capital, but it demands consistent skill and discipline. Prop trading is not an easy path, but for some seasoned traders it can unlock opportunities they could not achieve trading only personal funds. As with any high-stakes endeavor, success requires strong risk management and strategy. In the end, prop trading is best suited for experienced, disciplined traders seeking to amplify their impact by trading an organization's capital under structured conditions.

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