What Are Prop Firms in Trading? How They Work

Key Highlights

Online prop trading firms are specialized educational and trading companies that offer trading education to traders through practical evaluation challenges. These firms fall under four categories:

• Institutional Prop Firms
• Retail Prop Trading Firms
• In-house Prop Firms
• Remote Prop Trading Firms

Prop Trading Firms

The prop firm landscape continues to evolve year in, year out, and has, in the past few years, seen some of the most significant developments in the world of trading. A prop firm, short for proprietary trading firm, represents a unique business model - a model that has reshaped how traders approach trading. Dive deeper into this topic Prop Trading Business Model

Prop trading firms are attracting an unprecedented number of beginner and skilled traders looking to build their portfolios without risking their own funds. These are traders who wish to build profitable careers without having to overcome the traditional barriers that have historically limited trading.

And as traditional models continue to face increased scrutiny, traders have no option but to seek solutions that promise them profitability and scalability. For many, this option has turned out to be remote prop trading firms. Read on to learn what they’re and what makes them different.

What Are Prop Trading Firms?

The online prop trading firms refer to specialized educational and trading financial companies that offer trading education to traders through practical evaluation challenges. This is as opposed to providing the traditionally accepted and widely known client fund management services. 

In this landscape, you’ll find that there are different, distinct models, with each serving a different market segment. As a result, the prop trading firms NYC are bound to have different operational structures depending on the model they use, and the segment they serve.

Read about our latest guide about What Is Prop Trading?

It's worth noting that the best prop trading firms are unlike traditional brokerage firms. These tend to earn commissions from client trades, while prop trading firms, on the other hand, primarily generate revenue from evaluation and education program fees and profit splits.

Please be advised that the revenue models can differ slightly across the various categories. 

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Audacity Capital Empowering Traders Since 2012

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Types of Prop Trading Firms for Stocks

Before I take you through the various types of prop trading firms I know, I’d like to reiterate that prop trading firms work by providing capital to skilled traders.

Often, this is in exchange for performance. My years in the industry have shown that the more profitable and rule-abiding you’re, the higher the chances of you making it as a prop trader. 

The reason for this is that these firms will be looking to see whether you can stick to the rules they have set for you, even as you go about executing your different trades.

Now, having said that, please note that prop firms are typically split into two: traditional institutional companies and remote/retail firms.

My focus today is on the latter. I’ll be seeking to take you through the various types that exist below. The following is a quick look at the top four:

1. Institutional Prop Firms: A cursory look at any list of top prop trading firms will reveal the names of major investment firms, hedge funds, and banks. These are what we call institutional prop firms, and are companies that typically trade with hundreds of millions of dollars. Their traders are in-house employees whose focus is on using sophisticated strategies. 
2. Retail Prop Firms: The prop trading firms for beginners fall under this category, as their main focus is on providing education and skill development programs. Their target market is traders who wish to access larger trading capital and an opportunity to scale. 
3. In-House Prop Firms: These are a different breed of prop firms that require their traders to work in-house (from a physical office). In this setup, the company seeks to offer direct supervision, immediate support, and a collaborative trading environment. Such prop firms are known to offer closer mentorship and a more structured training program.
4. Remote Prop Firms: Last but not least on this list of prop trading firms are the remote prop trading firms, which, as their name suggests, allow you to work from any location. These prop firms leverage technology to provide their traders with remote skill assessment programs and ongoing educational programs. The remote model exploded in popularity post-2020 as it helped reduce operating overheads. 

As you contemplate these various types, please check out our guide on Comparing Prop Trading Firms. 

How Do Prop Firms Work?

Prop trading companies employ sophisticated operational models that are designed to help them maximize business sustainability and educational effectiveness. These firms must achieve all this while at the same time being able to manage their risk exposure. 

And while the frameworks may vary across remote, institutional, in-house, and retail prop firms' structures, the goal is oftentimes the same. As a trader, understanding the operational differences that exist between these firms will be crucial to ensuring you choose the right prop firm.

To get you started, we have prepared a detailed guide on how prop trading firms work.

How Are Prop Firms Different from Other Trading Models?

Gone are the days when trading was a preserve of the suit and tie types, often depicted on trading floors, busy yelling into their phones. Today, we have Solo traders who trade from the comfort of their homes, prop traders working with firm capital, and algorithmic bots making automated trades. 

But with so many trading styles and trading firms out there, it’s fairly easy to wonder: What are the things that make prop trading stand out from the other trading models?

Well, this section will help answer this question. 

How Does Prop Trading Compare to Other Forms of Trading?

Ask anyone who has been trading for more than a few months, and they’ll tell you that the trading world isn’t a single straight line, as many beginner traders would like to believe. It’s a world that can be equated to a map filled with all kinds of paths leading to different directions. 

On this map are folks who prefer trading from the comfort of their couch with a dream and a laptop. There are also those who’d rather sit behind a large desk filled with multiple screens and hundreds of millions of dollars under their management. And then you have the in-betweens.

If your dream is to become a prop trader and you’re unsure of whether to pay for an evaluation as you don’t know how it stacks up to the other types of trading, this section is dedicated to you. Join us below as we break down prop trading for you.

1. Retail Trading vs Prop Trading

Before you rush off to research the best prop trading firms to work for, you should first understand that retail trading is how many beginner traders get into this world. A retail trader, unlike a prop trader, is an independent trader. As such, they’ll be using their own money to trade and will access markets via brokers.

Some of the key characteristics of retail trading are:

• High potential rewards, but it comes with increased risk
• Self-funded, requiring a trader to use their savings
• Limited access to advanced and premium tools. Traders have to pay to access them.
• Complete autonomy over risk management and trading strategies
• In contrast, proprietary firms allow their trader to use the firm's capital 
• Prop firms have a structured risk management plan in place

Table comparison of retail trading vs prop trading.

2. Institutional Trading vs Prop Trading

Institutional trading refers to the buying and selling of financial instruments by large organizations, namely insurance firms, mutual funds, and pension funds, on behalf of their investors or clients. 

These are firms that have access to large capital pools, which is why their trading activities can impact traditional markets. You can look at it as massive trading supported by algorithms and research groups.

With institutional trading, those involved aren’t chasing fast profits. Their goal is to manage the funds at their disposal using thoroughly planned steps.

Its key attributes are:

• Larger workforce
• Focus on the investor’s needs
• Significant regulatory and legal oversight by the FCA and SEC
• Greater operational complexity 
• Operational objectives include liquidity provision, hedging, and managing portfolio balance.

Table comparison of institutional trading vs prop trading

3. Hedge Funds vs Prop Trading

A hedge fund is a privately controlled investment fund that uses diverse trading strategies to provide high returns. The investment patterns followed by hedge funds are different from those of mutual funds. 

In most cases, hedge funds prefer to use leverage and short selling to guarantee maximum possible returns. Their key attributes are:

• Operate on market cycles and investor mandates
• Structured for growth and wealth preservation
• Use arbitrage, macro, short, or long equity, or event-driven strategies

When it comes to prop trading firms, the traders have to work to generate revenue for the firm. From this, the company will then provide them with a percentage of the profits. Their trading accounts will also continue growing based on their consistency. 

A side-by-side comparison table of hedge funds and prop trading.

4. Quantitative and Algorithmic Trading vs Prop Trading

Quantitative and algorithmic trading have a very close relationship. But while this may be the case, you should note that algorithmic trading is, in fact, a subset of Quantitative trading. 

When it comes to trading approaches, algo traders use complex mathematical approaches, such as statistics and models to create strategies, while quantitative traders use computer-based systems. Therefore, one set of traders is focused on buying and selling, while the latter is focused on automation.

Key characteristics shared between them include:

• Driven by automated logic, history, and probability
• They require high-speed infrastructure and are often operated by specialized firms and funds
• While some prop trading firms support quantitative and algorithmic trading, many still cater to discretionary traders, leaving room for tons of flexibility within this model. 

Side-by-side table comparison of algo/quant trading vs prop trading. 

Audacity Prop Trading Challenges

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Audacity Prop Trading Challenges

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What Makes Prop Trading a Great Fit for Many Traders?

The reason prop trading stands out is that it has been able to combine two powerful worlds: the profit potential and freedom of trading for yourself, with the speed and tools of big institutions. In prop trading, you have an opportunity to trade with real capital, scale with a plan, and earn profits without risking personal funds. 

Prop trading is recommended for:

• Goal-oriented investors capable of following strict rules
• Self-employed innovators who need support, some tools, and structure
• Skilled traders lacking capital

How Should Traders Evaluate Prop Firms?

A rule of thumb when it comes to choosing the right prop trading firm is to understand that not all prop trading firms operate the same. Therefore, before you pay any challenge evaluation fee, be sure to assess the payout credibility, rule clarity, and more.

The following are a few factors to consider when researching the most trusted prop trading firms in forex:

Rule Clarity and Documentation

No rule matters more than this one! Many prop traders fail the prop-funded challenges because of breaching the rules. With regards to rule clarity, you’ll be looking for:

• Clear and unambiguous conditions on why funded accounts get terminated.
• Well-laid-out definitions of maximum drawdown and maximum daily loss
• Worked examples showing the moment a funded account fails
• A detailed explanation of how the prop firm calculates drawdown

Steer clear of prop firms where termination rules can be adjusted retroactively, interpreted, or explained differently across their website. 

Reliability and Payout Terms

High profit splits in a prop firm agreement are meaningless if its payouts are unreliable or easily disputed. During your evaluation of the best prop firms, try to concentrate on their payout mechanics, and not on the headline percentages splashed across their website.

For this, try to be on the lookout for:

• Conditions that can lead to delays or canceled payouts
• Identity verification documents that are required for a payout to be processed
• Minimum withdrawal threshold
• Clearly detailed payout schedules

Operational Transparency 

As a trader, this is what will help you understand what happens behind the scenes. If possible, try to request the following details:

• How the platform monitors and enforces its trades
• Whether the funded challenges and accounts are live or simulated
• What happens in the event of a dispute
• How often the platform changes its terms and rules

A reputable prop trading firm will have documented all these details clearly on its registration portal. If you find that the operational answers are inconsistent, buried in fine print, or vague, assume a higher risk. 

Conclusion

Prop firms provide capital to skilled traders in exchange for profit splits and the chance to scale up. The profit-sharing basis will depend on the type of prop firm and the model used. With regards to types of prop firms, you should note that there are four: institutional, in-house, retail, and remote. Each type will require a different kind of trader. A good example of a remote prop trading firm is Audacity Capital, a firm that requires its traders to pass an evaluation phase before becoming funded, and getting an opportunity to scale up. 

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