Prop Trading Vs Copy Trading

Key Highlights

Copy trading and prop trading are two distinct approaches to trading the financial markets, with each catering to different levels of personal capital, risk tolerance, and technical expertise.

 In a nutshell, these are their key differences and overlap areas:

• Copy Trading in Prop Firms: While most prop trading firms have strict rules against copy trading, some do allow it, and have gone a step further to provide internal copy features.
• Trader Copiers for Multiple Accounts: You can use “trade copiers” to manage several prop firm accounts at the same time, thus helping enhance your payout potential. Be advised that using a trade copier on a local PC requires a VPS (Virtual Private Server) to ensure 24/7 connectivity and low latency. The reason you need a VPS is because if your home internet blips for 2 seconds during a news event, the copier might miss a "Stop Loss" command, leading to a blown account.
• Prop trading is recommended for experienced traders who already have a profitable and consistent trading strategy in place.

Prop Trading Vs Copy Trading

Prop trading requires high skill and risk management as it involves trading the prop firm’s capital in return for a share of the profits. Copy trading, typically used by both beginner and expert traders, involves replicating the trades made by another, more experienced trader.

Prop trading provides a substantial capital allocation, eliminating the need to provide your own trading capital or collateral. When you look at copy trading and prop trading together, you’ll be able to notice a few things. For example, when it comes to risk, prop firms will strictly regulate the use of copy trading tools. And the use of unauthorized tools can lead to account termination.

The following is a detailed comparison of prop trading vs copy trading that will include taking a look at what each type of trading is and the differences that set them apart. Read on to learn more about the two!

Learn more about latest guide Compare Prop trading to other models

Prop Trading –The Definition

Prop trading involves financial firms or traders using the firm’s capital to trade and speculate on various financial instruments to generate profits. Depending on the firm's specific offerings, prop traders may have access to a wide range of instruments, including commodities, currencies, bonds, and stocks. And instead of executing client orders, prop traders execute trades on behalf of the firm, using the firm's capital to pursue profits based on their own strategies.

You should note that while personal market capital isn’t at risk, the initial investment (evaluation fees) and time spent undertaking the challenge are! This makes the evaluation fee a sunk cost.

Types of Prop Trading Firms

Prop trading firms can fall into numerous categories based on their focus and strategies. The most common types of prop firms include:

1. Event Driven Firms: These firms use specialized strategies to exploit price volatility caused by corporate actions or economic shifts.
2. Market-Making Firms: They’re trading firms that provide liquidity to the financial markets by quoting ask and bid prices on various securities. While a balanced book is a goal, their primary motivation is capturing the bid-ask spread while managing inventory risk.
3. High Frequency Trading Firms: These are firms that engage in high-frequency automated trading with the sole goal of profiting from small price movements. The high-frequency trading firms often rely on sophisticated algorithms and advanced technologies to execute high-volume trades.
4. Statistical Arbitrage Firms: These firms use mathematical models to exploit temporary price discrepancies between related financial instruments. Arbitrage companies use quantitative models and other complex strategies to generate profits.

Each type of prop firm mentioned above will come with its own preferred trading strategies and enforced risk management practices, thus allowing you to specialize in your preferred assets. But please note that online evaluation firms are quite different from institutional prop desks, most retail traders interact with Online Evaluation Firms, which focus on providing capital to independent traders who pass a specific skills test.

The skills test in question is the two-step evaluation where traders must hit a profit target (e.g., 8-10%) without hitting a maximum loss limit. P.S. Most firms set a 10-12% total drawdown and 5% daily drawdown.

What Is Copy Trading?

Copy trading enables you to automatically replicate the real-time buy and sell orders of other investors. This allows you to mirror the strategies of more experienced traders, including your own, directly within your own portfolio. And while copy trading requires less time on charts, it does require a high level of 'Managerial Analysis.' You must understand drawdown, equity curves, and risk-of-ruin to select a sustainable master trader.  Note: The risk-of-ruin is defined as the probability that a sequence of losses reduces capital to zero (or the drawdown limit).

How Copy Trading Works

Copy trading functions by allowing you to choose a “master trader” or signal provider whom you wish to follow. Once you have made your choice, the trading system will begin replicating all their buy and sell orders in your portal, based on the proportion of capital specified.

Please be advised that the master trader can trade a variety of asset classes, e.g., cryptocurrencies, Forex, commodities, and stocks, all of which will be mirrored into your account in real time.

Latency Warning: Copy trading always involves Slippage. The "Master" might enter at 1.1000, but the "Follower" might get 1.1002, which can turn a winning strategy into a losing one over time.

Benefits of Using Copy Trading

There are numerous benefits to using copy trading, such as:

• Fast, Convenient, and Beginner-Friendly: If you’re just getting started in the trading world, copy trading is not "set and forget." It requires active monitoring of the "Master Trader's" behavior, as they may change their strategy or increase risk levels (style drift) without notice.
• Risk Control Tailored to Your Specific Environment: Although you’re copying the moves being made by a master trader, the reality is that you’ll remain in complete control of your capital allocation. This means you can set your preferred budget, define acceptable risk limits, and stop copying at any time.
• Easy Access to Professional Experience: By using copy trading, you get to benefit from the strategies and skills of experienced traders. Every buy and sell order is copied in real time, which means you don’t have to analyze the financial markets on your own.

Strategies for Managing a Copy Trading Portfolio 

For beginner traders who choose to follow the copy trading path, the following are some important tips to consider:

• Choose Signal Providers with Consistent Performance: Trading isn’t always about posting high profits; solid risk management and consistency are what will matter in the long run.
• Set Your Parameters: Specify how much you’d like to invest per trade, and set a corresponding loss limit to safeguard your capital.
• Adjust Risk Based on Your Budget: Try to avoid all the actions taken by a trader during your early trading days. Where possible, start with a small allocation and raise this amount as you progress.
• Regularly Monitor Trade Performance: Keep track of the trading results being posted, and if need be, switch to another signal provider if the first one doesn’t meet your expectations.

Be Cautious of the Group Trading Trap: Firms monitor for 'herd behavior.' If hundreds of accounts execute identical trades simultaneously, it creates an unmanaged risk concentration for the firm, leading to disqualifications for prohibited 'coordinated trading. The reason for doing this isn't just about catching "cheaters," but about managing the firm's unmanaged risk concentration. If hundreds of traders execute identical trades, the firm's exposure to one market move becomes dangerously high.

Prop Trading vs Copy Trading: Key Differences

Here are the key differences between prop trading and copy trading:

Capital Source and Risk Management

Prop trading provides access to firm capital, often after passing an evaluation. Your financial risk is typically limited to evaluation fees and rule violations.

In copy trading, you use your own funds, and your performance is directly tied to the trader you follow. Losses are fully borne by you.

Strategy and Decision Making

Prop traders are responsible for developing their own strategies and selecting assets within the firm's allowed markets. However, they must operate within strict risk parameters, such as maximum drawdown limits that have been mandated by the prop firm.

And, on the other hand, copy trading is a passive or semi-passive process. Your performance relies entirely on the skill, strategy, and risk management of the "master trader." Once you select a provider to mirror, the execution of individual trades is handled automatically.

Prop Trading vs. Copy Trading Comparison Table

The Consistency Rule: Many prop firms have a "Consistency Rule" (e.g., no single trade can account for more than 30% of total profit). This is a massive hurdle for copy-traders that is rarely ever mentioned.

Conclusion

Prop trading is best for seasoned traders looking for ways to scale and enhance their earning potential. Prop firms will expect these traders to take and pass a multi-stage evaluation challenge for them to become funded. Copy trading, on the other hand, is best for beginners who don’t have the time or experience to analyze market conditions before making a trade. At Audacity Capital, our team of experts is available round the clock to help address any queries you may have regarding prop firm trading.

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