Prop Trading Vs Retail Trading

Key Highlights

Want to become an active trader but are unsure of which career path to follow? Here’s what you need to know to get started:

• Prop trading enables you to trade with the company’s capital. The prop trading company will provide you with capital, training, and the tools needed to earn profits, in exchange for a share of the earnings. 
• In retail trading, you’ll get to use your own savings to trade, but get to retain all the profits earned. However, this also means that you’ll have to take all the risk by yourself. 

Prop Trading Vs Retail Trading

Even if you’re not a professional trader, the chances are high that you have some level of exposure to the stock market: it could be through your IRA or via mutual funds. The fact that you have an idea of what these entails means you have an opportunity to turn your passive trading into something more active.

For those interested in pursuing professional trading, you’ll typically have two paths to consider: trade in a retail account or become a prop (proprietary) trader. If your interest lies in day trading, you’ll need to make a choice between opening an account with a prop firm or with a retail (online) broker.

When it comes to evaluating trading account options, many people focus their comparison process on costs and account features, and forget that these two products are different. In this guide, we will take you through everything you need to learn about comparing prop trading firms. 

Prop Trading – An Introduction

Proprietary trading involves financial firms using their own capital to trade financial markets. The prop traders aim to generate direct profits for the prop firm, allowing them to share in the gains, while the firm absorbs all the risk.

Retail Trading: An Overview

Retail traders don’t have the luxury of using firm capital to trade and have to instead use their own money when trading on online platforms. Individuals in this line of trading range from beginners to experienced investors, with independent decision-making being the one factor that connects them.

They do, however, benefit from increased flexibility, personal control, and decision-making over their investment decisions. 

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Prop Trading and Retail Trading: Key Differences Explained

Capital Access and Leverage Differences 

Prop and retail trading use very distinct frameworks when it comes to capital access and leverage. Their differences have a significant impact on risk exposure, position sizes, and profit potential. Below is a quick breakdown of their capital access. 

How Do Prop Trading Firms Provide Capital?

Prop trading firms use evaluation challenges to decide on the traders who’ll get access to their capital. This means that traders don’t have to risk their personal funds, thus enabling them to trade larger positions than before.

The leverage in these firms is structured around the prop firm’s internal policies and the risk capital deposited by the trader. These internal policies are designed to reward strong and consistent performances with increased leverage. 

Personal Funding in Retail Trading

As mentioned earlier, retail traders have no option but to trade using their savings. What this means for you is that every loss you make will have a direct impact on your trading capital.

It’s why  anyone considering this route should first ensure that they have a good risk management plan in place. Another thing you should know is that a trading platform may place some restrictions.

Some of the restrictions are based on the Pattern Day Trader rule. In most cases, traders who will be most affected here are those trading with less than $25,000.

What some traders  find disheartening about this rule is that they will be restricted on the number of times they can place a trade. This will, thus, constrain their leverage and trading power. 

The only way to overcome this is by depositing additional funds into the retail trading account. 

Risk Management: Personal Control vs Firm Rules 

Prop trading and retail trading take different approaches when it comes to risk management. Traders partnered with prop firms must abide by rigid, company-imposed rules. Retail traders, on the other hand, have the freedom to make their own decisions, although this does come with certain challenges.

Risk Controls in Prop Trading

Prop firms rely on non-negotiable risk management systems to minimize exposure and protect their capital. One such rule is the daily loss limit, which is typically set at between three and five percent of the available location. Hitting this limit will lead to a trading pause for the remainder of the day.

Retail Trading Risk Decisions 

The first thing you’ll notice when trading on a retail trading platform is that you’re responsible for your risk management plan. You get to set your own trading rules. But you must understand that this kind of autonomy will require you to have a high level of self-discipline to succeed. 

Prop Trading and Retail Trading Risk Management Methods Compared 

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How Profits Work: Profit Split Agreements vs 100% Ownership

How traders earn profits differs significantly between retail and prop trading. You need to understand that the profit distribution mechanisms in trading can be a game-changer. And understanding how these different structures work will help you determine which career path to follow.

Profit Splits in Prop Trading 

The profits made by the trader in prop trading are shared between the firm and them. It’s a setup designed to reflect the resources and risks involved. Often, the profit-sharing agreements will start at 50% and go as high as 90%, in the prop trader’s favor. 

100% Profit Retention in Retail Trading

Retail trading platforms have a different profit setup: here, the traders are trading their personal funds, thus allowing them to walk away with 100% of their profit. But while this may be the case, you have to note that the trader will also bear all the trading costs involved and carry all financial risks. 

You, therefore, must decide if you’d rather share bigger profits or keep 100% of smaller profits. 

Conclusion

Many traders choose to partner with retail brokers due to their perceived popularity. And while such a setup lets you walk away with all the profits made, ignoring the benefits offered by prop firms can prove costly in the long term. Prop trading accounts offer fair profit split agreements, access to educational resources, and trading tools for a share of the profits. All things considered, the kind of profits you’re likely to make with a prop trading firm will easily outrival those you can make on your own. To learn more about prop trading firms, make sure to check out the funded trader program offered by Audacity Capital today!

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