Prop Trading Vs Flow Trading

Key Highlights

Flow trading and prop trading use distinct risk management strategies due to the different trading styles involved. Prop trading, for example, involves using the firm’s own capital to open trade positions, while flow trading involves executing client orders and providing liquidity in the market.

In a nutshell, this is how prop trading fares when compared with flow trading:

• In prop trading, the firm will lose money if the trader places the wrong trade. And in flow trading, the client will bear all the risk involved.
• Flow trading is customer-centered, while prop trading involves chasing direct profits to benefit the firm and its traders. 
• There are rules to regulate prop trading in certain jurisdictions, e.g., the U.S, where banks are prevented from engaging in speculative trades with insured deposits. 
• Prop trading is recommended for aspiring traders as they can get access to funded accounts after passing an evaluation. Flow trading is best for those who wish to have a steady career.

Prop Trading Vs Flow Trading

The dynamic world of finance operates in such a way that traders are constantly faced with decisions that have the potential to make or break their careers. Understanding the nuances involved in different trading strategies will help prevent you from making losses when you should be earning big.

As I like to tell aspiring traders who come to me for trading-related advice, the trading strategies aren’t just about buying low and selling high. Each strategy is often rooted in a certain principle that has been designed to serve the trading style of a particular type of trader. 

Using our two strategies here, you’ll note that both involve using capital and trading diverse financial assets such as bonds, stocks, and derivatives. But did you know that they differ when it comes to their trading approach, risk tolerance, and purpose?

Moreover, a flow trader can only operate within the confines of the requests placed by their clients. Their job is to facilitate a transaction, from which their firm earns a commission.Prop trading allows traders to take larger positions, with the goal of making a direct profit. 

Learn more about latest guide Compare Prop trading to other models

Read on to learn about how prop trading compares to flow trading, and which is the best!

Flow Trading: What Is It?

Flow trading refers to a financial strategy where a trading company trades various financial instruments such as commodities, stocks, currencies, and bonds on behalf of its clients. In this case, the firm will be using the client’s money, rather than its own. 

The objective in flow trading is to facilitate client transactions and provide liquidity in the financial markets. Firms involved in this type of trading make money through the bid-offer spread and from commissions. 

Investment banks are the biggest beneficiaries of flow trading as they get to make profits while at the same time acting as intermediaries in the client transactions. Its applications include situations where a company serves as the market maker, allowing it to quote both the buy and sell prices.

This will enable it to profit from the price differences. 

What Is Prop Trading?

Prop trading is a trading setup where firms provide seasoned traders with access to their capital to engage in trading activities. This is as opposed to using client money, as is the case with flow trading. 

Permitting traders to trade with their capital enables the prop firms to retain all profits generated from price fluctuations and other market movements. It’s an approach that ensures that firms don’t have to rely on earning commissions from trading arising from client-related activities.

Please note that prop trading can include a broad range of financial assets, e.g., stocks, derivatives, commodities, and bonds. Prop firms commonly use this approach to benefit from opportunities arising in the market. They do so using analytics and advanced tools. 

For example, a prop trader can use a variety of strategies, such as merger arbitrage or global macro-trading, to exploit emerging market inefficiencies. By relying on these strategies, a prop trader is able to take a large position in a certain security, hoping to profit from market movements. 

How to Choose between Prop trading and Flow trading

Choosing which career path to follow – prop trading or flow trading – will depend on the resources at your disposal, your level of experience, past performance, and most importantly, your risk tolerance. The best way to explain this is by touching on the different experience levels in trading.

For example, if you’re a:

• Beginner Trader: Often driven by greed or hype. Most beginners focus on high profits, and lack a good trading strategy. A majority rely on the risk management plan provided by the prop firm. The beginner stage involves high emotional volatility and some potential losses.
• Experienced Trader: Prop trading is by far the best option for experienced traders looking for new ways to boost their earnings and scale up to bigger things. It lets them trade independently without having to worry about client concerns, but it does require a certain level of risk management.
• Other Traders: Independent and freelance traders should consider the total capital at their disposal and their appetite for risk. If they find that they have limited access to capital, they may want to start with flow trading and then slowly build up their reserves. Experienced traders and well-capitalized traders looking for maximum profit opportunities and independence might want to lean towards prop trading. 

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Strategy Implementation in Prop Trading and Flow Trading

Both prop trading and flow trading strategies will come with their own distinct prerequisites that are designed to align with their operational needs. Therefore, whether planning to become a prop trader or a flow trader, you may want to start by learning what each style requires.

Prop Trading

• Capital: The prop firm will provide the trading capital. Firms use this capital to fund traders and cover any losses arising from bad trades. 
• Skills: A prop firm will first test your trading abilities to determine whether you’re a good match for its funded trader program.
• Tools: The prop trading company will equip you with all the tools and resources you need to trade profitably. These will include risk assessment models and algorithms for automated trading. 

Flow Trading

• Capital: Relies on client money to help in executing trades. And this is often a service provided by brokers or banks to assist in facilitating market liquidity. 
• Skills: Traders who wish to work as flow traders will need to have excellent customer service, a strong understanding of market mechanics, and quick decision-making abilities.
• Tools: The main tools used in flow trading are firm-provided and include order management systems and other sophisticated analytical tools. 

Conclusion

It’s expected that prop trading and flow trading will continue to be shaped by advancements in the tech sector and by changing market trends. Flow trading, for instance, will be the biggest beneficiary of advanced data analytics and automation, as these will help enhance the speed and efficiency of transactions. Prop trading, on the other hand, will stand to gain from global economic shifts and heightened market volatility, both of which will present new opportunities for speculative trading. At Audacity Capital, we are a reputable prop trading firm that can help you get started with your prop trading journey today. Click here to learn about how our funded trader program works, and who can benefit from taking our evaluation challenge. 

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