Prop Trading Business Model

Key Highlights

Prop trading has undergone three important phases to become what it is today. In a nutshell, these phases are:

• The early days of using in-house capital and local edges
• Shift to the electronic era of multiple screens, fast execution speeds, and new trading models
• Modern prop firms that are characterized by rules, challenges, and global access

Prop Trading Business Model

The origins of proprietary trading predate Discord-based trader communities and paid remote evaluation challenges. During the early days, this business operated via physical spaces where prop traders worked with firm capital, were monitored by risk managers, and phones rang to signal inbound orders.

However, the combination of market infrastructure development, regulatory changes, and technological progress eventually forced these trading systems to undergo a transition. In this transition, the prop firms got to move from physical spaces to server-based systems.

These are systems that came complete with a challenge dashboard platform and dashboard interfaces that significantly transformed the way traders accessed firm capital. Thanks to this evolution, traders are now subject to established rules and can trade from any location. Read on to learn more!

Read more about What Is Prop Trading?

The Early Days of Proprietary Trading: In-House Capital and Local Edges

Old-school proprietary trading shops were run more as a family organization as compared to the modern-day prop trading platforms. The trading edge and ownership of capital remained restricted to specific people who gained access by first working as bankers or through specific recommendations.

Early Proprietary trading companies displayed the following characteristics:

• Simple Products: The focus was on index products, a few futures contracts, or specific options markets. In the early days, specialization was seen as the norm, and not the exception.
• Physical Presence: Prop traders needed to keep a close eye on certain market types while shouting predicted prices. The combination of fast execution speeds and local market understanding is what contributed to the success of these firms.
• Loose but Personal Risk Control: Just because the prop trading business model was different at the time doesn’t mean rules didn’t exist. As is the case today, limits existed, but were typically managed in person.
• In-House Training: Unlike today, where much of the training occurs remotely and online, training during the early days was done face-to-face, where senior traders helped mentor their juniors. Aspiring traders got to learn the skills of the trade by sitting next to experienced traders and watching them.

Traders needed to work from specific locations and establish strong professional relationships while demonstrating their expertise to access the prop trading company’s capital.

Shift to the Electronic Era: Screens, Speed, and New Trading Models

The transition from local edges to electronic markets brought with it two important changes, which helped speed up market information delivery while reducing trading speeds. And this meant that the prop trading industry had no option but to adapt its operational methods.

Some of the major shifts during this period included:

• Remote Possibilities: Experienced traders got the nod to work from home and other off-site locations, even though the infrastructure remained centralized.
• Rise of Systemic and Quantitative Approaches: Prop trading firms began to use data as a fundamental element in their operations. This led to firms and traders using a combination of strict execution rules and back testing with statistical methods to gain a trading advantage.
• The Shift from Trading Pits to Modernized Platforms: Experienced prop traders replaced hand signals with multi-screen setups and DOM ladders, focusing on chart structure and order flow.

It’s this phase that helped lay the groundwork for modern-day remote prop trading possibilities, which uses rules-based systems to connect prop traders worldwide.

Modern Proprietary Trading Firms: Rules, Challenges, and Global Access

The past decade helped usher in remote prop trading companies , which soon established themselves as modern-day trading firms. In this prop trading business model, clients are required to pay for an assessment to assess funding.

Learn mor about How Prop Trading Firms Work

During this assessment, they’ll get an opportunity to demonstrate their ability to comply with the prop firm’s rules while striving to achieve the profit targets set out for them. Today’s prop trading companies provide traders with:

• Flexible Access: You can trade from any location provided you have a stable connection. Traders now have the flexibility to trade on multiple asset classes and on multiple platforms.
• Transparent Payouts and Scaling: Prop firms guarantee regular payout cycles that come with defined scaling milestones for traders who show consistent profitability.
• Challenge-Based Onboarding: Traders need to pass onboarding evaluations that have one or two phases. Each phase will have clear risk rules and well-defined profit targets.

The challenge system enables prop firms to identify skilled traders by testing their trading performance at various phases. Traders must observe established boundaries when trading to gain access to a funded account that comes with a scaling opportunity, while eliminating the need to use personal funds.

Read more about Prop Trading Challenges and Rules

How the Challenge Model Became the Favorite Route of Funding for Retail Traders

The trading world has undergone various changes as I have noted above. And while some of these changes have been tech-driven, I can confidently say that regulatory bodies have also played a role.

If you’re just joining this field, you may not know this, but prop trading was once an exclusive domain for those in the banking industry.

At the time, only the lucky few were able to access the exclusive bank-based trading desks. But all this changed a few years back with the enactment of the Volcker Rule.

Its passage saw banks being restricted from taking part in certain speculative investments. And just like that, trading suddenly became a decentralized, digital industry.

I happened to join the trading industry around this time, allowing me to witness the ongoing evolution of prop trading. Some of the changes I have so far witnessed include the shift from in-person trading to remote-based evaluation platforms.

As these changes continue to take shape, their effects can be seen in the number of global talents that are today able to access firm capital. So, how did the evaluation model become so popular?

The challenge/evaluation model widely used by proprietary trading firms became the favorite route of funding for retail traders for several reasons. Top among these is that it eliminates personal financial risk on any losses incurred, provides access to a larger capital pool, and forces trading discipline.

In this prop trading business model, retail traders pay a relatively low, one-time fee to enter a simulated “evaluation.” Successful participants get to manage firm capital instead of trading with small personal accounts, in return for a 70% to 90% profit split with the prop firm.

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The following is a look at why the evaluation model is a hit with retail prop traders:

1. Minimal Personal Risk: The only cost to you is the one-time fee to access the evaluation. Some firms will refund this fee upon passing. But if unsuccessful, the firm will retain it, and if you fail while trading, the company will absorb the loss.
2. Structured Discipline and Skill Building: Prop firm evaluations are designed to test trader discipline and require participants to adhere to certain strict rules. Examples of these include profit targets, consistency rules, and drawdown limits.
3. Evolution from Multi-Step to One-Step Challenges: Firms initially relied on long, multi-phased challenges to evaluate traders. This model later evolved into single-step challenges that enabled traders to access funded accounts in as few as 10 days. Click here to learn more about How Traders Get Funded?
4. Access to Larger Capital Allocation: Many retail traders are limited by the amount of capital they can afford to risk in their trades. Prop trading firm evaluations serve as a filter that assists in identifying skilled traders, who are allowed to access larger capital allocations.

Conclusion

Prop trading firms have evolved from family-run organizations relying on local edges to worldwide distributed networks using established rules and dashboard systems. But as this evolution unfolds, the core agreement between the prop trading companies and their traders remains the same: the firm provides operational structure and financial backing, while the trader gets to generate steady returns without breaching the rules in place. While modernization has made it possible for more people to join the trading world, it has also helped raise the performance standards. And as a trader, your success will depend on your ability to select a firm that can match your trading approach. Audacity Capital is an established trading firm renowned for matching consistent traders to scaling opportunities.

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