So you want to become a proprietary trader?

[Alchemist]

Several people asked me both on Trading-Lab and elsewhere what the best course of action would be in order to become a proprietary trader (also known as a prop trader) and join a proprietary trading firm. Most common questions range from the very general “How do I become a proprietary trader?” to “What exams or licenses do I need to join a proprietary trading firm?”. Some even took it a step further and asked me, “How much do proprietary traders get paid? And can I join a proprietary trading firm with no degree? Do I need to get a Series 7 license?”. For those of you who don’t know me yet, I have decided to embark on the proprietary trading path back in 2002, and joined one of the major prop shops later that year.

Truth is, becoming a proprietary trader these days can be relatively easy. Getting to retain your proprietary trader status, on the other hand, is a totally different can of worms. Let’s first try to define what proprietary trading is all about in today’s mainstream investment banking world. Wikipedia defines proprietary trading as a term used to describe when a firm’s traders actively trade stocks, bond, options, commodities, or other items with the firm’s money as opposed to customers’ money. That is, the firm trades for its own accounts and for its own profit. This definition, however, somewhat differs from most of proprietary trading firm’s business models nowadays.

In fact, almost 100% of the traders who asked me the above mentioned questions referred to proprietary firms like Echotrade or Bright Trading, just to name a few, which follow a quite different business model from the firms Wikipedia is mentioning on its website. Let’s analyze the whole process of becoming a proprietary trader these days in 3 easy steps and understand what it really means to you as a trader.

So, you wanna be a prop trader? Let’s shop around!!

• Capital contribution

That is correct: the vast majority of proprietary trading firms these days require a deposit in the form of cash from you. This deposit goes into your capital account at the firm once you get your Series 7 and other licenses, and join them. Funds deposited into your capital account are segregated from other traders’ money. This means your deposit is shielded from other traders’ losses. However, your money is not immune to anything that might happen to the company as a whole (i.e. bankruptcy, etc). In the event a trading firm should become insolvent and go bankrupt, you should consider yourself lucky if you are able to get a percentage of your money back. This is the reason why it’s good practice to always leave just a little over your deposit requirement in your capital account, and wire your profits out of the firm and into your personal bank account on a regular basis.

Deposit requirements do vary. The average is around $10K but I’ve heard of firms that will take you with much less than that. So why do trading firms need a deposit from me for? “They” say to separate the serious traders from the wannabes. Truth is, any losses resulting from your trading activities will be taken from your capital account money. More on that in Step 3!

• Series 7 and other licenses

Most proprietary firms are required by law to have their prospective traders take and pass a Series 7 exam in order to be awarded a “registered representative” license. Some firms also require additional licenses depending on their exchange membership or affiliation. I’ve heard that prop firms which are affiliated with NASD also require a Series 55. Most prop shops are members of a regional exchange in an effort to keep costs down.

The vast majority of the material covered by a Series 7 examination if pretty boring, if you ask me. However, that is just my opinion. FACT is you have to take it if you want to become a proprietary trader! So get your books ready and be ready to read Step 2 to relieve the pain!

• Commission rates are negotiable.

That is correct: commission like many other expenses are negotiable in a contemporary proprietary trading setup. Competition among proprietary firms is fierce nowadays. Most of them concentrate on competing on commissions. So let them try and go as low as they can! Whether you will get the commission rate of your dreams, however, depends on how “big” of a trader you are. Big, of course, refers to how many shares a trader is able to put through the system on a daily, weekly, or monthly basis. To most proprietary firms, a prospective trader is really nothing more than an average shares traded figure. Period.

Groups of traders command lower commission rates, and it’s not uncommon for the team leader to get a cut of the whole group’s commission figure they generate. If you know of a few traders who are interested in trying proprietary trading or who already are prop traders, it makes sense to get together as a group and shop around for rates a bit. Hell, you may even get to be the team leader!!

• Got training?

As mentioned in the previous paragraph, most trading firms try to compete on commissions. In my opinion, they would have much better success and provide a better service if they offered valuable in-house training to their new traders. After all, most new traders are better off joining a prop firm offering mentorship and training and charging a higher commission rate, than a firm offering rock bottom rates but no training whatsoever. Always inquire about training and move those firms who do offer it higher in your list. You will surely benefit from it on a long term basis.

• Desk and software fees

Nothing is free, didn’t you know that?! Proprietary trading firm these days give you the option of either trading from the comfort of your home or in one of their offices nationwide. If you choose to trade from home, you will be charged for software fees at most, in addition to regular commission on your trading activities. However, if you decide to trade from one of their offices (which I highly suggest since you will be able to really live the “life of a prop trader”), you will be charged a desk fee on top of your software data fees. This desk fee basically covers various expenses relating to the seat or room you are going to occupy in their trading office. Good news is that most firms will rebate back part or all of your desk fees at the end of the month, depending on how many shares you traded. This, of course, is just another way to lure traders into trading and generating more and more commission.


Got your Series 7 yet?!

As already mentioned earlier in the article, proprietary firms require their traders to get a Series 7 license. The Series 7 exam is a computer administered and highly timed exam. Personally, I like highly timed exams as they force you to think and process information fast. Now, if Series 7 material were a bit more interesting!

In order to get a Series 7 license, you have to be sponsored by a company. Then, you have to prepare a few forms, get fingerprinted, and schedule a test date. Most of the exam covers securities industry rules and regulations as well as basic exchange workings. In addition, you will be tested on basic option pricing valuation. I highly suggest you start studying for the exam at least one month in advance. Best thing would be to first study the material and THEN take lots of sample tests which are available from most exam prep providers. This way, you will have already accumulated enough experience with the material and the test format and you will pass it on the first try!

You have become a proprietary trader. Now what?

You have shopped around. You found a firm you really like. You have passed your Series 7 test and finally signed the firm’s membership agreement. You have now become a proprietary trader! Now what?

As I said in my second paragraph, becoming a proprietary trader can be relatively easy. After all, you don’t need expensive IVY league degrees to get in or a crazy amount of money to start. Getting to stay in the proprietary trading world, however, is a totally different story. By that I mean to actually becoming a PROFITABLE prop trader.

As some of you may already know, proprietary firms offer their traders higher leverage than a retail firm would (and can). Most firms usually start their traders at 10X their equity. This means that if you contribute $10K to your capital account, you will be allowed to trade up to $100K worth of stock on an intraday basis. This, of course, will grow once they get to know your trading style and depending on the risk level of your trading strategies. It’s not unheard of traders getting buying power of up to 50X+ their equity.

Leverage, or course, is a double-edged sword. It can make lots of money to the successful trader, but it can ruin a brand new trader getting his feet wet. Leverage is to be taken lightly. In my opinion, 10X equity is way more than any new trader would ever need during his first few month of live trading. Use leverage allocated to you cautiously!

Most prop firms requiring a deposit will let you retain 100% of your profits. They will also let you eat 100% of your losses! Those firms taking traders with little to no money will either charge higher commission or will split any profits their traders generate. This is their way of getting “rewarded” for the additional risk they are taking in requiring less up-front money from you. Since under both scenario you will be responsible for all your losses, it makes sense to gather any additional funds you are missing and go with the firm letting you keep 100% of your profits!

Spend the first 6 months of your life as a proprietary trader trading 100-share lots, unless you are a seasoned trader already. Take your time to experiment with several different strategies and get to know as may successful traders in your office as you can. That is the beauty of trading from an office: getting exposed to successful traders and getting some precious trading insight out of each one of them. This is the only way to really understand what proprietary trading is all about. Proprietary trading can be a life changing event, if approached correctly. You want to be part of the prop gang? Play by the rules!!

[scalper]

great article! It answers all my questions from my previous thread http://www.trading-lab.com/forums/do...rader-t53.html in great detail, and even more!

[rookie]

probably the best article on proprietary trading I read so far!

[TapeReader]

a great in-depth look at proprietary trading and a few great tips. Thanks!

[jd1028]

Alchemist,
Thinking seriously of joining a prop. Here is my question. Lets say I am using firm leverage to $1mm. Will I have a problem if i own 4 stocks at 250k each? or do i need to own 10 stocks at 100k,20 stocks at 50k each etc.... i guess my question is how does the risk management work from the firms standpoint-i've read alot of threads but i really would like a thumbnail sketch of how it works.

thanks in advance

[Alchemist]

jd1028,

very good question. even though I have never worked in a risk management department, theory suggests holding 10 stocks at $100K each would be less risky than holding 4 at $250K each.

Truth is, there many other variables involved in the risk management process. Do the stocks have news? Are the stocks you are trading volatile? Are you holding just longs or shorts or a good mix of them? Do the risk management guys know your trading style very well (and its risk)?

These are just a few of the variables involved in risk management. So my best answer would be: it depends on the particular situation.

From personal experience, many times I went over my buying power but never got a call from anyone at the risk management department. However, they knew very well the type of trading I was into and its associated risk.

hope this helps

[Arbitrageur]

prop trading in the US is usually about trading stocks, prop in the UK and Europe is almost always about futures.

NFA is not required to trade UK/Eur prop, and the regulator in the UK does not get involved in prop trading unless you are trading client funds (rather than your own, or the firms). More info here: http://www.trade2win.com/knowledge/a...ading-arcades/

[mkha98]

Alchemist,
Thank you for your overview.

Some follow-on questions:
1.) Names of the best 2 - 3 companies for initial training.

2.) After how many hours do you expect people to make a living ($100k annually consistantly); after how many hours do you expect people start making surplus income ($200k)?

Thanks,
mkha