Most people have heard of proprietary trading, which describes institutions (usually banks and other large financial institutions) that trade securities and other leveraged financial instruments in their own accounts. Historically, proprietary trading (or Prop Trading) has been a largely institutional affair. Banks and large financial institutions hire the most experienced traders to watch the market and open and close positions. However, today's Prop Trading environment is more diverse, with a lower bar for entry.
Breaking Down the Characteristics of Prop Firms
The current typical proprietary trading firm (or Prop Firm) is a boutique investment firm that works with beginner traders and provides them with the training and capital to buy and sell securities and derivatives using their own strategies. Unlike banks and large financial institutions that employ traders, the typical prop firm engages a trader and gives them capital and the freedom to make their own moves. The firms then agree to a sharing formula for the generated capital. In addition, most prop firms agree to absorb losses in case the market moves against the trader's strategies.
The Changing Landscape of Proprietary Trading
These firms have three defining characteristics. First, they are open to engaging with beginner traders. Legacy prop firms (i.e., banks and large financial institutions) almost exclusively favor traders with years of experience. They believed that this caliber of trader had the right mix of knowledge and expertise to grow capital in the global financial markets. This belief was not false because access to crucial information was only possible through a deep connection to the industry. However, the internet's ubiquity changed things; anyone with sufficient motivation and discipline can find their way into the global financial markets.
Second, prop firms provide remote access to retail traders. Remote proprietary trading refers to trading financial instruments with a prop firm's money from any location worldwide instead of the firm's trading floor. In fact, a typical prop firm does not have a physical trading floor.
Third, prop firms employ prop traders on a contract basis. The firm provides all the tools necessary for the contractor to generate substantial capital, including high-end software, research and insights, and unfettered access to the global financial market.
In short, a conventional prop business has no one definition or description. However, all prop firms have one thing in common: traders.
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