Proprietary Trader

Traders from newbies to grizzled veterans have probably asked themselves at different times, “Should I become a proprietary trader?” The answer depends on your needs and goals, and requires some research on your part.

The first step would be to figure out why you might want to become a proprietary trader. There are several benefits to being a prop trader – access to capital, comraderie with others, and superior technology are the main ones.

Experienced traders with successful strategies can reap huge benefits from the extra capital available to them at a prop firm. Compared to a retail account, you can generally trade 5x-10x bigger as a proprietary trader, so for traders with scalable strategies, joining a prop firm can really boost profitability.

traders looking at computer screensFor newer traders that are starting to see some success, the professional relationships with other talented traders can help you put the final pieces of the puzzle together. Particularly if you can be part of an office environment, there is insight to be gained just from being in a room with successful traders.

The technology offered at a prop firm can be helpful, as well. Generally, you will get more powerful software, better market data connections, and more access to trading venues in a prop trading firm. For example, IEX has been beneficial to many traders as a place to route orders that isn’t as subject to HFT predatory tactics as the other exchanges. Prop firms will have access to IEX and allow you to route your orders directly to them, while at other firms, you may not have access to IEX at all. You can also route your orders to dark pools, place orders at midpoints, or use sophisticated algorithms that seek out liquidity in multiple ways.

As a side note, for traders at retail shops like ScotTrade or Ameritrade, you usually see a very limited list of available routes for your orders, often just the major exchanges or a “Smart” route. What actually happens is that your order is offered first to their partners in an arrangement called “payment for order flow.” This means your broker is paid for sending your order to them instead of directly to the market. Obviously there is a reason these third-party firms are willing to pay to see your order first. For instance, say the NBBO (National Best Bid and Offer – the official inside market) is 61.25 x 61.27. You send an order to buy at 61.27, and you get an execution at 61.269. You think, “great, I got better than the inside market,” but the execution is 1/10th of a penny better just so the third party could justify jumping to the head of the inside market. There is a reason they are willing to do the trade at a better price for you. In liquid stocks, a lot of trading happens at the midpoint. Odds are, in this stock there is a hidden midpoint order at 61.26. The third party sells the stock to you at 61.269 and can immediately turn around and buy it back at 61.26. At a prop firm, you would have the order types that would allow you to send an order at that midpoint and possibly buy the stock at 61.26 instead of 61.269. On a 1000-share order, that’s a difference of $9. If you are trading significant volume, that can really add up over time. Now you know how they can offer $4.99 trades – they are getting paid by that third party for your order, and that third party is using your order to get advantageous fills.

For the extra capital and access to technology, the prop firm takes a cut of your profits, usually somewhere between 10%-20%. If you are trading 5x bigger and giving up 10% of your profits, you still come out 4.5x more profitable as a proprietary trader than you are on your own, so if you can put the extra capital to good use, this is an easy tradeoff.

Most prop firms are broker-dealers, so you will need to pass the Series57 exam and get registered with the firm. This is the Equity Trader exam, so studying for it is generally very straightforward for traders with existing market knowledge.

If you are a trader with discipline and a strategy that provides consistent success, a prop trading firm is a great way to take your profitability to the next level, in an environment that supports your efforts alongside other professionals in the industry.

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