Prop firm business model

[Tubbs]

I've been to a prop firm & it left a strange feeling - however, can anyone answer the question:

What is the business model of a prop firm? If traders are 80% losers then how do prop firms survive. Most investment banks make money on trade commisions. This could be true of a prop firm with the seat fee & commisions, but they also give you the money to trade with, negating the previous costs.

Anyone have an idea how it works. As there are so many of them popping up you would presume it is a lucrative as being in spread betting. I don't need any help seeing how that works!

 

[Directional]

aside from graduates, a trader generally wouldnt even start at an arcade unless they already had a proven trading method because the desk fee's alone would take them into the red, if their trading didnt do that for them.

Trading at an arcade wont make you profitable if you arent already, though if you ARE profitable then an arcade can help make you even more so. So the traders who would be at an arcade would probably already be in the profitable trader category.

arcades as a business may make a margin from the desk fee they charge, the commissions they levy and from margining and leverage services they provide to traders that want extra buying power.

 

[SOCRATES]

First of all it is an averaging excercise.

The top crack traders are relied upon to make substantial profits for the house and themselves.

The house hopes to be able to attract several more of these.

There are several problems involved in such recruiting, in two parts:~

The top crack traders are already successful in their own right and are self financed and independent.
And, the ones that actually hire a seat in a prop house do it for a reason, which is to be able to trade sizes they would not be able to trade via their own margins, additionally.

The difficulty for the house is that these sacred monsters are loners and do not share their methods or indeed their edges with anyone, so the idea of newcomers benefitting from mentoring is a pipe dream.

Having said that, the house recruits whom they percieve may have potential to make them money.

But the house is not able to graft on to these newcomers the proficiency of their existing sacred monsters who guard themselves jealously.

The house hopes that with a perfunctory series of superficial explanations that they call "training" these newbies can be brought up to be consistently successful like the sacred monsters.Observe the use of the word "hopes". This is because the house itself is not able to extract the contents of the sacred monsters' minds in any event.

The house employs psychologists, in the erroneous assumption they can wave a magic wand and turn the unsuccessful ones into stars. Nonsense !

All of these traders have to pay fees to the house for the priviledge of being given a seat, hardware, access etc., so that provides an income stream.

Another income stream is the sharing of commission. As the turnover is humungeous then this is substantial.

The turnover is encouraged to be humungeous, even though this kind of churning to turn over a few ticks here and there is not necessary, but is embedded as part of the culture of prop houses.

All newbies are supervised and made to operate with tight stops in order to limit inevitable losses.

Like a casino, where the punters have no idea of whether they are going to win or lose on the throw of the ball on the roulette wheel, but the house has the advantage dependent on turnover, so, in a similar scenario in which the outcomes are dependent upon conditions of uncertainty rather than committment via certainty or near certainty, you can consider the idea as a similar model transposed into another parallel arena such as trading.

I expect this satisfies your enquiry.

 

[SOCRATES]

aside from graduates, a trader generally wouldnt even start at an arcade unless they already had a proven trading method because the desk fee's alone would take them into the red, if their trading didnt do that for them.

Trading at an arcade wont make you profitable if you arent already, though if you ARE profitable then an arcade can help make you even more so. So the traders who would be at an arcade would probably already be in the profitable trader category.

arcades as a business may make a margin from the desk fee they charge, the commissions they levy and from margining and leverage services they provide to traders that want extra buying power.

Quite so, your post is shorter and you were able to get it in before my long one, but I absolutely concur.Many thanks for your kind message, btw, I will pass it on, much appreciated.

 

[Tubbs]

A marvellous post, thank you. I admit it all makes sense. The prop firm interview/sales pitch that I attended did not make me think I was anyone special if I got the prize of working there, and paying mill owner to do so!

It makes sense if they want you to limit your/their losses but still give them fees & commissions.

Great posts thanks

 

[TWI]

If traders are 80% losers

Why do people use these stats? I think the 80% you talk about are not therefore traders. In the arcades people who lose do not stick around for long as they cannot afford it.
Today it is a lot harder in these shops than it used to be as the market arbs have tightened up and volatility in Euro interest rates has died but there are sometimes a few stars that cover the losses of the less fortunate.
I have seen grad programs that generated significant profit for the sponsors and those that have lost. It is impossible to know when employing the traders which way it will go but be clear about one thing, the arcade really does want you to make profit as they will not make money out of you if all you do is lose even if you do make many round-trips.
It is a big risk backing traders as the initial drawdown is far more than you might expect in a traditional business. If I offered you an investment but told you that I would be likely to lose 40-50% of your money before I started to make anything you may not like the idea, but this is reality of a normal grad scheme.
The only thing I disagree with is the arcades that ask traders to put in their own money. As then they could conceivably rip people off but otherwise I think the grads are on to a good potential opportunity. It just should be remembered that you should not expect to earn anything much while learning and that is often accepted upfront but resented down the line.

 

[Tubbs]

Sorry about the 80% twalker - I just was implying that there are a lot more losers than winners. I guess what I'm trying to say is that I just don't think it is possible to take some grads and teach them to be successful traders. I really do agree with socrates on this one. Surely a few good traders must support the prop house. As for the point that bad traders don't last long, well I agree, they don't that's why they are always looking for new people. As I said the prop firm I went to gave a sales pitch. I can't speak for all of them though.

 

[tsuntzu]

It never ceases to amaze me the amount of people who like to venture an opinion on the arcade business model when I doubt that they have been exposed to it (twalker ignore). All you hear is negative this negative that. I would just like to set the record straight. I managed about four separate groups of trainees that I helped recruit and mentor. A total of about 30 guys. Now this was about 4 years ago when things were not as tight as they are now. All but 3 of them are still trading, they all make 6 figure salaries and a few of them have even gone beyond that. I know for a fact that the profit from these groups dwarfed the revenue stream from the commission business. At the end of the day I am not naive enough to think I was solely responsible for there success. However I do not think it was luck that these grads made money either. You get people who have a passion for this business and who want to succeed and the battle is part won, for every 500 apps I would pick just 8. Okay not all arcades are the same but its unwise to tar them all with the same brush.

 

[Tubbs]

Fair points tsuntzu, I should have more faith.

 

[SOCRATES]

It never ceases to amaze me the amount of people who like to venture an opinion on the arcade business model when I doubt that they have been exposed to it (twalker ignore). All you hear is negative this negative that. I would just like to set the record straight. I managed about four separate groups of trainees that I helped recruit and mentor. A total of about 30 guys. Now this was about 4 years ago when things were not as tight as they are now. All but 3 of them are still trading, they all make 6 figure salaries and a few of them have even gone beyond that. I know for a fact that the profit from these groups dwarfed the revenue stream from the commission business. At the end of the day I am not naive enough to think I was solely responsible for there success. However I do not think it was luck that these grads made money either. You get people who have a passion for this business and who want to succeed and the battle is part won, for every 500 apps I would pick just 8. Okay not all arcades are the same but its unwise to tar them all with the same brush.

I am very interested in your reply and very pleased to hear of your success.

I do not venture opinions. I have views. I have them because of my experience, which is considerable, and the ins and outs of arcades both here and in the US and elsewhere are very well known to me indeed, so it is not as if there is negativity for negativity's sake, but there is incisive inside knowledge here and that is what makes the difference.

I have three questions for you.

1. You say that out of every 500 apps you would pick 8. This is an exceptionally high ratio.
Does this mean you set standards at a level of tolerance such that the filter for entry is not so tight or do you think you are able to attract the best ?

2. Can you attribute a reason why, once these people become successful as you say, and acquire personal wealth from their endeavours they should want to continue to commute to the office every day rain and shine (excluding reasons of camaraderie within peer groups) instead of doing it either from home or an exotic location ?

3. Given that conditions today are tighter than 4 years ago (according to my frame of reference conditions have not changed, but that is a matter of perception) do you think you could replicate this result over the next four years and if not, why not, and if positive, why so ?

Your response is awaited with interest.

 

[Tuffty]

If traders are 80% losers

A total of about 30 guys. Now this was about 4 years ago when things were not as tight as they are now. All but 3 of them are still trading

Should that be 90% then?

 

[tsuntzu]

1. You say that out of every 500 apps you would pick 8. This is an exceptionally high ratio. Does this mean you set standards at a level of tolerance such that the filter for entry is not so tight or do you think you are able to attract the best ?

I wouldn'e be so bold as to say we attracted the best, if anything I found a shortage of people with the qualities I was looking for. Every time we ran an Ad. we would get 500 odd apps. from people who thought they were just applying for a 'job'. I found that having been around a lot successful traders having an informal and relaxed chat with applicants I could hone in on similar attributes that I was looking for. I only ever would do this with about 30 before whittling it down to 8 or so.

2. Can you attribute a reason why, once these people become successful as you say, and acquire personal wealth from their endeavours they should want to continue to commute to the office every day rain and shine (excluding reasons of camaraderie within peer groups) instead of doing it either from home or an exotic location ?

These are young people on average sub 26. I haven't come across many people that age who would want to spend all day everyday at home. The camaraderie aspect is a big aspect. We had a lot of fun together. The biggest factor is that the way we trade you need speed, that speed is not available at home, unless you invest a considerable sum of money. In the office you get an analyst squawking news and 30 pairs of eyes watching the market like hawks spot more then one pair. That said, the guys now trade in places such as Spain, South Africa, Canada and the US. Nothing I would describe as exotic but I am sure they are happy. I myself trade at home every now and again, but I just prefer the office, I feel that will change though as my needs and wants mature with age.

3. Given that conditions today are tighter than 4 years ago (according to my frame of reference conditions have not changed, but that is a matter of perception) do you think you could replicate this result over the next four years and if not, why not, and if positive, why so ?

The word tighter is maybe not the correct word, I cannot quantify the term statistically. However I feel that as a screen based futures trader who has traded day in and day out for the last five years that the moves are not as dynamic and free flowing now as they were back in the infancy of screen trading. Economic releases have less short term impact and the daily ranges are smaller. However getting back the question. I do believe that I could replicate the result over the next four years or indeed any time frame although the actually success rate may trend lower. Why so? because in the same way that I am confident that every day I sit down I am going to make money, then by the same measure I think I can pick quality candidates, and give them the support they need to develop into successful traders. I will not be so bold as to speculate as to the the degree of success that they would obtain though.

Hope that goes some way to answering your questions.
All the best

 

[Parky]

Prop trading model

Prop houses continue to succeed and will continue to do so as they have a sound business model which may not always be apparent to the outsider.
They make money on commissions, they make money on sit down costs and they make money on the trading.
To an outsider the figures may not make sense as the prop house takes 100% of the pain and yet only makes 40 - 10 % of the profits depending on the commercial splits agreed with the traders.
As stated above the most successful traders are self financing and this is the wholly grail for most traders starting out.
However some very successful traders stay at prop shops out of loyalty and some due to pure laziness, but the "new" successful traders will generally stay out of loyalty to the shop that gave them the chance, trained them and set them on their way and as long as the split and clearing rates are commercial too the business they are doing (i.e. the prop house doesn't get greedy) then these are the guys on which the whole structure is built.
A prop shop should, if they have there risk management set up correctly, limit losses and allow the traders to make maximum capital with leverage etc. so in practise one successful trader easily covers the losses of several loosing traders.
No one expects trainees to make money immediately and most prop shops expect a slow burn and to loose money for the initial period but a properly constructed trainee trader program is a long term project and once the trainees have the confidence and expertise the commission generated from higher round trips and P&L splits will more than compensate the company for the initial looses.
However, as we have seen from other threads, as commissions get squeezed, percentages get squeezed, leverage growing out of all proportion too the funds on account and companies starting up with totally inadequate balance sheets we will envitably see failures in the future as with the Griffins and ICAs of the past. But despite this the prop shop is here too stay.

 

[SOCRATES]

I wouldn'e be so bold as to say we attracted the best, if anything I found a shortage of people with the qualities I was looking for. Every time we ran an Ad. we would get 500 odd apps. from people who thought they were just applying for a 'job'. I found that having been around a lot successful traders having an informal and relaxed chat with applicants I could hone in on similar attributes that I was looking for. I only ever would do this with about 30 before whittling it down to 8 or so.



These are young people on average sub 26. I haven't come across many people that age who would want to spend all day everyday at home. The camaraderie aspect is a big aspect. We had a lot of fun together. The biggest factor is that the way we trade you need speed, that speed is not available at home, unless you invest a considerable sum of money. In the office you get an analyst squawking news and 30 pairs of eyes watching the market like hawks spot more then one pair. That said, the guys now trade in places such as Spain, South Africa, Canada and the US. Nothing I would describe as exotic but I am sure they are happy. I myself trade at home every now and again, but I just prefer the office, I feel that will change though as my needs and wants mature with age.



The word tighter is maybe not the correct word, I cannot quantify the term statistically. However I feel that as a screen based futures trader who has traded day in and day out for the last five years that the moves are not as dynamic and free flowing now as they were back in the infancy of screen trading. Economic releases have less short term impact and the daily ranges are smaller. However getting back the question. I do believe that I could replicate the result over the next four years or indeed any time frame although the actually success rate may trend lower. Why so? because in the same way that I am confident that every day I sit down I am going to make money, then by the same measure I think I can pick quality candidates, and give them the support they need to develop into successful traders. I will not be so bold as to speculate as to the the degree of success that they would obtain though.

Hope that goes some way to answering your questions.
All the best

Very interesting replies, many thanks, tsuntzu.