Trading with prop firms may seem attractive for Forex traders, especially those that do not have experience and a large starting capital. But traders should be warned that, besides the obvious advantages in trading with prop firms, there are significant disadvantages that can make you think twice before starting to seek a prop firm to trade with.
Before discussing prop firms, we should establish terminology.
A proprietary firm (often shortened to prop firm) is a firm that seeks out prospective traders who will be trading on the firm's behalf with the firm's capital.
Instead, a retail trader will most probably encounter scouting firms. These are online firms that typically do not have a physical trading floor. They provide a trader capital in exchange for a portion of profits that the trader will earn as well as a flat fee. This is the type of a firm this guide discusses.
The obvious advantage of prop firm trading is that a trader does not need a large starting capital. In theory, you can start trading if you have just a few hundred bucks to pay the fee to the prop firm. And such prop firms do not require specialized education or prior experience. In fact, some prop firms offer training and guidance to their traders.
So, does this mean that you can come to a prop firm knowing nothing about trading and it will just give you money with no questions asked? It sounds too good to be true. And the model, where a firm gives money to anyone who asks in the hope to get a return from them later, looks extremely unsustainable. Surely, there has to be more to this, right? Well...
Of course, a prop firm is not going to give its money to just whomever. Prop firms establish an evaluation period. During this period, you will be trading a demo account. If you pass the evaluation, you will get trading capital in a real account. In return, the firm expects a percentage of profits as well as, usually, a flat fee. To pass the evaluation, you have a profit target as a percentage of a starting capital on your account (for example, you may need to have at least 10% of your starting account in profits by the end of the evaluation period). There is also typically a limit on a drawdown you are allowed to have. There can also be other limits on your trading.
By themselves, all those requirements are not unreasonable. After all, the firm is risking its own money. So, it is fair for it to make certain that you know what you are doing before funding you. Alas, evaluation requirements and fees can lead to some unfortunate consequences.
Forex traders sometimes ask if prop firms are scammers. The simple answer is no, they are not. Being a prop firm does not make a company automatically a scammer.
That said, while not all prop firms are scammers, plenty of them are. Prop firms are unregulated virtual entities that are attractive to new and inexperienced traders. It is easy to see how that makes it appealing to scammers to pose as a prop firm.
Scams can take many forms. Not allowing withdrawal of your funds is an obvious one, though it is not limited to prop firms specifically. Firms that operate proprietary trading platforms can use them to manipulate quotes, making traders experience losses in an otherwise profitable trade. And scam prop firms can have evaluation requirements that are simply impossible to meet.
Talking about requirements.
Forex traders should be wary of evaluation requirements imposed by prop firms. Even if you can theoretically meet them, usually they are too high for an average trader. And even an experienced and successful trader can have an unlucky period. Of course, nobody prevents you from trying again. It is just that you need to pay the evaluation fee again. And here lies the problem.
In fact, the most cited argument against online prop firms is that unlike in the case of the more traditional proprietary firms their interests are opposite to the interests of traders. While the old-school prop firms are interested in their traders, being their employees, to be as profitable as possible, online prop firms that target retail Forex traders are more interested in collecting fees from traders. It is argued that the main source of income for scouting firms are fees they collect from traders, not profits the traders gain. That incentivizes prop firms to make certain that as few as possible traders pass their evaluation. And even if you manage to pass the evaluation, your prop firm is likely more interested in collecting a flat fee from you than helping you to achieve profitable trading.
But if you are certain that you have a profitable strategy and want to try as hard as possible to pass the evaluation? Well, that can be a problem by itself. Because of...
Prop firms can have severe limitations for their evaluation period. While the drawdown limitations are the most common ones, there can be others like limitations on news trading and weekend trading. Some firms may even not allow you to hold your positions overnight. Others may require a minimum number or value of trades during the evaluation period, a week, or even a day.
All those limitations and requirements can severely mess up your strategy and hamper your trading, making it even less likely for you to meet the evaluation requirements. They can make you avoid high-risk strategies that can put your over the drawdown limit even if can ultimately result in very profitable trading. The requirement of a minimum number or value of trades can make you take risky trades that you would not otherwise. And in general, the evaluation requirements are typically more favorable to short-term strategies, meaning you may need to abandon your profitable strategy if it takes a longer time to achieve a decent profit.
To distill all the mentioned points into a short conclusion: evaluation requirements often severely limit trading strategies, making it even less likely for you to pass the evaluation.
But even if you are a successful trader that has passed the evaluation one question still remains.
Let us assume that you are a successful and experienced trader with a profitable trading strategy. That likely means that you have already acquired decent capital. So why do you need a prop firm? What for? Yes, you will not be risking your money but the money of other people. But that also means that those people can dictate you their own terms. Do you really want to sacrifice your freedom for safety?
You should also consider the ratio of your profits the prop firm will take. While some firms have a reasonable split of profits, others take a huge chunk of profits for themselves.
Some traders may also be worried that the prop firm will steal their profitable strategies. Such traders speculate that prop firms employ specialists that analyze the strategies of people who are trading with the prop firm. And if some of those strategies are profitable, the prop firm will start to use those strategies in its own trades. For some people, that may sound like a conspiracy theory. But you may want to consider such a possibility if you have a trading strategy that you do not want to share with others.
While Forex prop firm trading may seem attractive, especially to newbie traders, it has plenty of pitfalls that traders should be aware of. There are good reasons for traders to trade on their own instead of trying to join a prop firm. Inexperienced traders are likely to become targets of scams and will have trouble getting funding even from legitimate firms. Experienced traders have the potential to get more profits on their own than with a prop firm.
Of course, nobody says that you cannot combine the two approaches. Some traders argue that it is a good idea to try to join a prop firm while also keeping making your own trades. After all, online prop firms typically do not require you to trade only with them.
Whatever your opinion on prop firms is, you should carefully consider all the downsides listed above before making a final decision.
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