Proprietary Trading: How It Works and the Benefits

May 19, 2023


Proprietary trading - Black Eagle

Proprietary trading, or “prop trading,” has a broad definition in the financial industry. Essentially, prop trading involves using your company’s capital to trade stocks, bonds, commodities, and other financial instruments instead of using a client’s funds.

Financial institutions engage in prop trading by separating their proprietary traders from their client-centered trading operations. For individuals or small trading firms, prop trading is an alternative to creating an account with a traditional broker to execute traders (also known as retail trading).

In this guide, we’ll delve into what proprietary trading is, how it works, and what the advantages are for companies and individual traders. 

What Is Proprietary Trading?

The definition of proprietary is “relating to ownership,” so proprietary trading refers to a style of trading that involves spending capital you own instead of using someone else’s money. A company conducting prop trading can keep 100% of the earned profits, and they don’t have to answer to their clients regarding transactions.

The typical strategies of prop traders primarily revolve around arbitrage, which is the practice of taking advantage of price discrepancies in different markets. For example, a prop trader might use a strategy known as risk arbitrage to profit when a company buys out another company, causing an inverse share price change.

Prop traders that trade with a prop trading firm use the company’s funds, trading tools, and other resources like risk management and support teams.

What Are the Benefits of Prop Trading for Financial Institutions?

For many financial institutions, proprietary trading often makes up a majority of their profits. Instead of earning revenue solely on commissions and fees, institutions can maximize their gains by using their own capital to participate in the market.

Prop trading enables institutions to maintain an inventory of securities to offer to clients as an advantage and hedge against illiquid or down markets when buying and selling securities is difficult. The practice also allows the company to act as a market maker, initiating trades with clients that want to sell illiquid securities quickly.

Proprietary trading - Black Eagle

Are There Restrictions on Prop Trading?

A federal regulation known as the Volcker Rule became law in response to the 2008 financial crisis, with the purpose of restricting large banks and hedge funds from making the type of speculative investments that caused the recession. Under the Volcker rule, financial institutions like banks cannot engage in proprietary trading for short-term investments. Instead, they must rely on commissions to earn profits.

The rule is intended to protect the best interest of the institutions’ customers by limiting potentially harmful short-term trading of securities, derivatives, and commodity futures.

Many people in the financial industry have criticized the Volcker Rule because it prevents banks from important market-making activities that provide liquidity to their customers.

How a Proprietary Trading Firm Works

Proprietary trading firms, or prop firms, are financial companies that give traders access to their capital in exchange for a cut of the generated profits. Prop firms can be a helpful starting point for new traders or experienced traders who want to advance their careers.

Traders at a prop firm have access to the company’s capital, learning resources, support, and sophisticated trading technology. With these tools in hand, they cultivate skills and become adept and knowledgeable traders, which might not have been possible on their own. 

As a prop firm trader, you can take on more risk and work with larger positions while using advanced trading tools. You also have built-in connections through the prop firm to seasoned traders who can guide you when you need help or insight. 

While prop firms vary in size and benefits offered, they share a common goal of wanting their traders to thrive. Some firms might even offer incentives and competitive compensation packages to encourage traders.

Advantages of Working with a Prop Trading Firm

When you become a prop firm trader, you get access to a variety of benefits that help you further your career as a trader. These benefits include:

As a prop firm trader, you can use the company’s capital to trade a variety of financial instruments, allowing you to quickly and easily get started trading and growing your account. You might also get training and education to teach you the strategies of trading.

If you’re a new trader that needs support, you can reach out to experienced traders on the team for help. Some prop firms connect you with a mentor to provide professional advice.

Another advantage prop firms provide is a risk management team that helps you manage risk while trading, which is beneficial for all traders no matter their experience level. On top of that, you’ll also get access to exclusive trading technologies that can give you a competitive edge in the market, including trading platforms, analysis tools, and data feeds.

Choosing the Right Prop Trading Firm

Finding the right prop trading firm for you starts with researching various firms and talking to representatives to discover their offerings. You should look for a company that shares your investing goals and has a sterling reputation. Additionally, you should make sure the firm offers high-quality customer service and is attentive to your needs. 

Prop firms carry higher risk than trading with a traditional broker because they don’t have the same regulatory protections, so it’s essential to do your research before signing off on an agreement. You should ensure you understand the terms and conditions of your contract and are aware of the risks involved.

Learn More About Our Trader-focused Approach to Prop Trading

At Black Eagle Financial Group, we offer numerous advantages to our traders, including cutting-edge trading platforms, extensive routing options with the ability to customize routes, capital security, competitive pricing, and more.

Our traders have full control over their trades while using our capital, benefitting from comprehensive customization options that allow the optimization of proprietary trading results. Our pricing structure strives to meet the needs of each trader, and we offer flexible payout schedules.

Interested in learning more about Black Eagle and our resources for traders? Contact us today.

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