How to Start a Prop Firm: The Complete Guide (2024)

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Overview

As we move across the various aspects of starting and running a prop firm, this complete guide will take an in-depth look into what a prop firm is, how it works, and how you can start one after considering all the benefits it brings.

After Covid-19 swept the financial markets and showed us we can be our own bosses through trading, forex, stocks, and other assets were no longer just distant financial instruments reserved for Wall Street professionals. Instead, they were a means to financial freedom. It goes without saying that trading the market is a difficult profession. But you already know that. Otherwise, you wouldn’t be looking into starting your own prop firm. With this being said, let’s go ahead and highlight the key insights you need to know for running a prop firm.

What is a prop trading firm?

A prop trading firm, also known in the industry as a prop desk or a proprietary trading firm, is a finance-focused institution that makes its money by trading in the financial markets. The largest advantage of a prop firm is that it uses its own capital to trade in any market possible. It could be stocks, futures, cryptocurrency, gold, commodities, oil, forex, you name it.

Once you know you have the funds to cover your operations and make investments, it’s go time. In other words, you are now hunting for talent that will do the trading together with you and your capital. The profits are split in any way you like – you can leave 80% to them and keep 20% for you.

Qualifying traders are usually put through a test – a two-step evaluation process that proves to you that these traders are worth the investment. Once you have selected a few of those, you can start allocating capital and watching how they perform.

Simply put, a prop trading firm is a financial services company that engages in trading the financial markets with its own capital. It also onboards traders and funds them with company capital in order for them to go out in the markets and turn a profit using the firm’s funds.

How to start a prop trading firm?

White Labeling

In order to start a prop trading firm, you need the right technology. In the industry, this is called white-label technology and it allows you to make use of advanced and sophisticated software. White label technology refers to the technology that leverages a licensed software product ready for use.

In practice, this is the trading platform that you share with those prop traders that go out in the market and turn a profit. Ideally, it should also come packed with a trading desk, admin panel, and an investor CRM portal to navigate all operations. Picking the proper trading platform is key when recruiting new traders to work with you as they will be using the software daily. You can choose from a variety of white label providers but do your own research and due diligence before committing to one.

Registration/License

Once you have selected a reliable white label technology provider, it’s important to either register the business in your respective legislation, or obtain a license for performing trading activities. These two are preferred steps as they will help you earn a legitimate status for your traders to trust. In turn, this could be essential for your long-term success, growth, and expansion. It may also open more doors for you as you go and talk with banks and liquidity providers.

When you get registered as an entity, you will give your business the proper status it needs in order to operate freely and work with banks, institutions, government agencies, etc. More importantly, you will be able to present your business to investors and clients and onboard new partners and users.

While some shy away from registering their operations, doing so will open more doors than simply running your operations with a registration. As you go along with a registration, you will also feel more confident to take on rivals and improve your own services.

The financial market is a constantly working machine that waits for no one. And to stay ahead of the curve, you need to be quick, innovative, and forward-looking. All those you can achieve with a registration as it will provide the groundwork for you to build upon.

Liquidity/Funding

Before you run a prop firm, you must be sure you have enough liquidity to operate and sustain your business practices for the foreseeable future. You can get liquidity by opening funding rounds and raising the cash you need. You can approach high net worth individuals with the aim to get funded or you can commit the capital from your own assets.

CRM Tool

As you set out to run a prop firm, you need the right CRM tool to help you manage all of your operations. A comprehensive system that will enable you to track activities, generate reports, and continuously deliver uninterrupted service to you and your traders. The better CRM you invest in, the better your overall performance ought to be.

Why do you need a prop firm?

Running your own prop firm is a surefire way to get maximum exposure to all those headline-grabbing stock movements, market rallies, early-stage opportunities, and whatnot. It will provide a never-ending stream of exciting market-related adventures that can carry you into a whole different financial status.

Keep in mind, however, that there are certain risks you need to consider before jumping on the prop firm train. You need to be able to guarantee ample liquidity at all times and you have to factor in market risks when you trade. Proper risk management and capital allocation will be your best friends for the long-term success of your prop trading venture.

How does a prop trading firm work?

With a prop trading firm, you can do two main market-related activities – trading and investing. And the way you do them with the people you recruit as traders will determine how successful you are.

Trading and investing are the two main ways you can approach the wide financial markets. They can be used in virtually any asset class, from stocks, through currencies, to crypto assets.

What you choose will depend on your own style and character. Still, both offer valuable techniques and strategies that could get you handsome returns both in the short-term and the long-term.

This said, the possibility of combining trading and investing would most likely be more difficult but more rewarding.

Trading strategies you can use with a prop firm

Trading strategies used by prop firms differ mainly on two fronts: the analysis used and the time frame of market exposure. Traders can go both long and short, depending on their preferences and views of market developments.

• Scalping: a trading strategy that’s performed in the shortest amount of time possible. Practically, the aim of this approach is to “scalp” small profits from imminent moves in stocks, currencies, or other assets.
• Day trading:: this strategy is focused on capturing intraday moves, or those happening in a single day. In other words, your trade should be opened and closed within a single trading day. This is preferred if you don’t want to roll a position into the next day, thus avoiding any unfavorable news.
• Position trading: a strategy for the financial markets that allows you to profit from ongoing trends. Spotting a trend is difficult when you trade in a single day. Position trading, on that note, could be stretched to several days in order to find a trend and ride it out.
• Swing trading: this strategy aims to take advantage of relatively longer price movements. Typically, swing trading is the trading strategy with the widest time horizon. It could span to several weeks of holding, so that once a trend is identified, it could develop and finish.

Trading pros and cons

Pros

• You can go both long and short
• You can take advantage of small intraday moves
• You can use high leverage for quick profits
• Diversification through more trading opportunities
• You can enter and exit quickly in every market

Cons

• You need to monitor your positions almost constantly
• Closing positions early can result in missed profits
• High risk if no stop loss order is used
• Can be costly until mastered

Investing strategies you can use with a prop firm

Investing done by prop firms has many forms and variations but perhaps the most popular ones are these:

• Active investing: this is an investing strategy that suggests an active management of your positions and funds. More specifically, it implies a significant amount of time in your day is devoted to monitoring and nurturing your portfolio. This investing style aims to outperform the so-called index investing, or investing in benchmark stock indices like the S&P 500. Once your active investing returns more than the S&P 500, you get to call your returns ‘alpha’ returns, or superior to the benchmark.
• Passive investing: this investment style is suitable for a prop firm that wants to put its money into an index and stay invested. The goal of passive investing is to let your assets grow without you fine-tuning every little detail of it. You can just buy an index like the 30-stock Dow Jones Industrial Average and match your performance to its own for a given period of time. Essentially, this style tracks the performance of the broad stock market.
• Value investing: a more specific approach in investing, value investing is fitting for a prop firm as it seeks to find undervalued companies with long-term perspective for catching up to potentially bigger valuations. Warren Buffett is perhaps the brightest example of a value investor. He’s been holding value stocks, or those from relatively old and non-glamorous industries, for decades.
• Growth investing: this is a modern investment strategy that aims to scoop up shares of companies with long-term growth potential. Companies that are able to scale infinitely, like technology giants, are considered the best growth companies. Growth companies are the biggest companies in the world with Apple in the lead, worth roughly $3 trillion. This is because they have their future earnings expectations baked into the current price.

Investing pros and cons

Pros

• Capture longer-term trends
• Less worry over positions
• Easier to buy and hold than trade actively
• Opportunities to diversify
• Historically, stocks have provided steady returns

Cons

• Higher risk of portfolio drawdown
• Short-term fluctuations
• Emotionally challenging
• No guaranteed returns
• Stop losses would most likely not work

A prop trading firm will not only be beneficial to you in the short term but also in the long term. As time goes by and your firm gets more popular, you will have a good chance to be spotted by new high-profile investors, and opportunistic traders and market participants.

How to sustain your prop firm in the long run?

To properly handle your daily operations as a proprietary trading firm, and those of your recruited traders, you need to maintain a robust level of risk management. In other words, the way you handle your trading activities will be crucial in making sure your prop firm will survive even the most bizarre and unexpected market events and circ*mstances.

Why is risk management important for a prop firm?

As a prop trading firm, the way you handle risks will mean whether you win or lose. That’s why risk management is crucial when you set out to run a prop firm. Not only does risk management evaluate the downside in any trade of any of your traders, but it also aims to capture the most upside possible.

Put simply, risk management minimizes losses, and maximizes profits. As you oversee traders, you will be faced with multiple choices to decrease the risk or increase the risk. Thanks to risk management, you can be certain your prop firm will endure even the worst of storms.

And because the global financial markets are complex and involve countless factors at play, there will be lots of financial storms.

The way to protect your portfolio from outsized risks is to design a clear and robust trading strategy. A solid trading strategy, on this note, will help your prop firm stick to a plan, or a set of rules, that will help you get the most profit with the least amount of risk.

Ideally, your trading strategy should be tailor-made to fit your trading style, risk tolerance, and overall approach to markets. You can, of course, seek traditional trading strategies which would likely say you need to diversify and never risk more than 2% on any given trade.

So, what’s an outsized risk? This is the amount of funds that you have not planned to lose. In other words, losing more than you have intended. In turn, this could make coming back to your starting point increasingly more difficult.

How to protect your prop firm from risks across markets?

Essentially, your choices narrow down to the following markets:

• Stocks
• Forex
• Indices
• Commodities
• Cryptocurrencies

Each one of these markets, or asset classes, has specific risks. Stocks, for example, get pressured by disappointing earnings reports. Forex pairs may be knocked from unfavorable geopolitical developments. Indices are likely to get swayed by economic uncertainty and Federal Reserve decisions. Commodities such as gold and oil could see sudden drops if investors pivot quickly to more fashionable assets like stocks. And cryptocurrencies, as the newest wonder of technology, are famous for their daily volatility and aggressive swings.

Risk management strategies using leverage

Getting into the markets as a prop trading firm is almost always related to using leverage in order to magnify your potential profits. And if you’re not aware how leverage works, it could put serious dents into your prop firm. Once you step into the financial markets as a prop trading desk, you will see hundreds of quotes, flashing in green and red. The allure of the trading platform could be a double-edged sword. In reality, the easiest thing would be to go ahead and start trading, opening positions across assets.

While easy, this could cost you your funds unless you base your actions on strong convictions and strategies. For example, a leverage of 100:1 would mean you control 100 times more than your capital. More specifically, $1 invested will be worth $100. Therefore, it’s important to approach any trade with caution and keep in mind that the power of leverage goes both ways. It could maximize your profits but it could also work in reverse and eat into your funds.

Taking risks in trading and investing is mandatory if you want to progress and grow, both in financial terms and professionally. To this end, make sure you realize the risks involved in trading and always use proper risk management strategies that will help you accelerate to higher grounds in the world of trading and investing.

Benefits of a running a prop firm

A properly structured prop trading firm can be a highly lucrative activity. From owners, to investors, to traders, everyone can benefit from all market opportunities, provided they are handled the right way. The markets are always trading and offering chances to build wealth.

When you trade through a prop firm, you get to keep 100% of the profits you make. When you recruit traders to do the trading for you, you get to keep as much as you have decided, while giving traders what is left. As mentioned above, the ideal profit split is hard to find but goes 80% for the trader and 20% for the prop firm.

The more successful your prop firm is, the easier it will be for it to expand, attract new capital, bring in more traders, and keep rolling. In short, with a prop firm, your opportunities are limitless

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