robbmickey
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The Ambiguous Nature of Modern Prop Firms by John Knott
Scour the the online forums and you will find countless threads asking what a prop firm is. Perusing the jobs boards and one will find endless listings of proprietary trading firms looking for high frequency traders. Even in the media there are countless references to prop desks at large banks and how they seem to be able to print money quarter after quarter. But what exactly is a prop firm and how does one get a job there.
There certainly is a lot of ambiguity that surrounds these firms and for good reason. All these firms are very different with some being very easy to get into and others being almost impossible to get an interview. Let's start with a basic building block. The word proprietary does not refer to strategies they use but rather capital. It simply means, you are not a broker executing orders for clients but using either firm capital, your own capital or some combination of the two. This is an important distinction as it governs how these firms are regulated and the types of leverage that is available to them.
There are many wanna be traders out there that often get angered when they apply to what they think is a proprietary trading firm only to find out that they have to make a capital contribution. This may be in the form of an training fee or a direct deposit into a pool of capital. The anger stems from the fact that they believe they should not have to contribute capital. These types of firms are of course the ones on the bottom of the prop food chain but their existence does serve a valid purpose. Not everyone can work on Goldman's prop desk. In fact, if one were to add up the total number of true proprietary firm backed traders in existence, they would find that there are more professional PGA golfers then true prop traders. Let me put this another way, you probably have a better chance of playing on the PGA tour then getting a firm backed position. Even if you don't know how to play golf!
This means that most traders will have to settle for prop lite. Prop lite means you can join a "professional" trading firm where you can get "professional" leverage and perhaps even have access to highly skilled programmers and in house proprietary software, but you will be forking over your own cash. Is this fair? You bet it is. Because what is the alternative? Goldman is not going to hire you and the few true prop firms out there that back their traders have an endless supply of MIT, University of Chicago and Cal Tech graduates to choose from. In fact even among that highly skilled talent pool of Ivy League grads, even they have a better shot at playing professional golf vs getting one of these coveted jobs.
And the bad news is, it's going to get harder. As more and more computers are trading around the clock in every corner of the globe, there really is no need to have a 24 year old kid with a mountain of college debt making discretionary decisions in fast markets with firm capital to enhance his ego or impress the girl he is going to hit on at the bar tonight. It's much safer and profitable for the firm to keep that guy in the back room writing software code where the only emotion he or she has to battle is boredom.
It wasn't always like this. Not too long ago there were many ways one could break into the business while leaving their checkbook at home. For decades the tried and true method for breaking into the business was working on one of the many trading floors as a clerk. Kids as young as 18 would works summers and then full time carding trades for locals in the pits. It was a great way to learn the business, meet a lot of people, see how the markets function and learn how to trade. If you picked it up quickly and impressed enough people, one of them would put you on a badge and actually back you in one of the pits. Many of famous "Market Wizards" from the Jack Schwager trilogy got their start this way. But then the floor slowly went away and that door would close for good.
In the late 90's and early 00's, we saw the emergence of the daytrading shops. While at first these early firms were what we call now, deposit firms, many of them fully backed their traders. One of the more famous ones was Worldco. But there was a reason why these firms could afford to take risks on new unproven traders and that was commissions. Lots and lots of commissions. The model was simple, bring guys in, charge them really high rates, give them incentives to trade as much as humanly possible and try to cut the bad traders as soon as possible and let the good traders ride. Sound familiar? These firms realized that they could make more in commissions then what they would lose in losses. The model worked well for many years until volatility slowly came to a halt around 2003. Once volatility dried up, so did the volume. And with the volume gone, so were the commissions. Firms simply could not afford to take the risk of backing traders without the commission buffer. Game over.
Next up were the futures firms. With equities dying, suddenly futures became the big game in town. And they used a similar model to equity prop firms. Since futures are already leveraged, nobody wanted to take the risk of letting guys come in and swing for the fences, so most of these firms endorsed the spread trading model. They primarily traded the yield curve. By trading spreads, the commission income made sense and the risk traders were taking was more controlled on top of the fact that debt markets actually lended themselves well to spreading strategies. So once again firms could lean on commissions as well as rebates offered by the exchanges for providing liquidity to buffer against the losses they had to absorb from bad traders. Of course the bad news is, eventually volume began to dry up here as well and the same cycle begins to repeat itself.
This led us to where we are today. The pay to play model. Technology has just gotten to the point where it can do everything you can do faster, cheaper and it doesn't eat, require sleep and or need a bonus and healthcare benefits. It's pretty hard to compete with that. But there are firms out there that will let you try, it's just going to cost you. Some firms will let you come on board for 5k, others want 25k to 50k.
So why join one of these pay to play firms? There are several reasons. One of course is leverage and lots of it. Other reasons include lower commissions, better software and the ability to learn from others. Let me address this last point, the ability to learn from others. This is probably the last best edge available for newbie traders. The ability to sit next to and learn from other traders, particularly profitable traders. There is nothing better then gaining knowledge from those that came before you. It truly is as close to the holy grail as you are going to get. And I'm not implying that you are going to learn some secret method from these traders but rather you are going to learn a process. A way of looking at the market. You are going to get inside the head of other traders to see how they approach every trading day. Trading by yourself at home will never give you this opportunity.
Is discretionary trading dead? This is often asked on online forums being that all one sees in the job market is ads for high frequency algorithmic traders with the ability to program in c##. No, discretionary trading is not dead and will never go away. But it's also not where the opportunity is. The real opportunity is going to be on the programming side. Or on the financial services side allocating money to these high tech quant firms. In the last few years we have seen an explosion in 3rd party software. We have seen the emergence of trading blogs with content that rivals that of The Wall Street Journal. We have seen the emergence of niche sites that provide information in very clever and unique ways for the every day trader. Of course there is also no end to the get rich infomercials and red light-green light trading systems.
The deal now is, going forward, young men and women are going to have to work for it. If you really want to be a discretionary trader, you might have to get a night job. Or a day job while learning to trade markets over night. You are going to have to save your money and once you have enough capital, put it on the line and takes your chances. The success rate will be the same as it always has, low, very low. But the reward will be high.
Scour the the online forums and you will find countless threads asking what a prop firm is. Perusing the jobs boards and one will find endless listings of proprietary trading firms looking for high frequency traders. Even in the media there are countless references to prop desks at large banks and how they seem to be able to print money quarter after quarter. But what exactly is a prop firm and how does one get a job there.
There certainly is a lot of ambiguity that surrounds these firms and for good reason. All these firms are very different with some being very easy to get into and others being almost impossible to get an interview. Let's start with a basic building block. The word proprietary does not refer to strategies they use but rather capital. It simply means, you are not a broker executing orders for clients but using either firm capital, your own capital or some combination of the two. This is an important distinction as it governs how these firms are regulated and the types of leverage that is available to them.
There are many wanna be traders out there that often get angered when they apply to what they think is a proprietary trading firm only to find out that they have to make a capital contribution. This may be in the form of an training fee or a direct deposit into a pool of capital. The anger stems from the fact that they believe they should not have to contribute capital. These types of firms are of course the ones on the bottom of the prop food chain but their existence does serve a valid purpose. Not everyone can work on Goldman's prop desk. In fact, if one were to add up the total number of true proprietary firm backed traders in existence, they would find that there are more professional PGA golfers then true prop traders. Let me put this another way, you probably have a better chance of playing on the PGA tour then getting a firm backed position. Even if you don't know how to play golf!
This means that most traders will have to settle for prop lite. Prop lite means you can join a "professional" trading firm where you can get "professional" leverage and perhaps even have access to highly skilled programmers and in house proprietary software, but you will be forking over your own cash. Is this fair? You bet it is. Because what is the alternative? Goldman is not going to hire you and the few true prop firms out there that back their traders have an endless supply of MIT, University of Chicago and Cal Tech graduates to choose from. In fact even among that highly skilled talent pool of Ivy League grads, even they have a better shot at playing professional golf vs getting one of these coveted jobs.
And the bad news is, it's going to get harder. As more and more computers are trading around the clock in every corner of the globe, there really is no need to have a 24 year old kid with a mountain of college debt making discretionary decisions in fast markets with firm capital to enhance his ego or impress the girl he is going to hit on at the bar tonight. It's much safer and profitable for the firm to keep that guy in the back room writing software code where the only emotion he or she has to battle is boredom.
It wasn't always like this. Not too long ago there were many ways one could break into the business while leaving their checkbook at home. For decades the tried and true method for breaking into the business was working on one of the many trading floors as a clerk. Kids as young as 18 would works summers and then full time carding trades for locals in the pits. It was a great way to learn the business, meet a lot of people, see how the markets function and learn how to trade. If you picked it up quickly and impressed enough people, one of them would put you on a badge and actually back you in one of the pits. Many of famous "Market Wizards" from the Jack Schwager trilogy got their start this way. But then the floor slowly went away and that door would close for good.
In the late 90's and early 00's, we saw the emergence of the daytrading shops. While at first these early firms were what we call now, deposit firms, many of them fully backed their traders. One of the more famous ones was Worldco. But there was a reason why these firms could afford to take risks on new unproven traders and that was commissions. Lots and lots of commissions. The model was simple, bring guys in, charge them really high rates, give them incentives to trade as much as humanly possible and try to cut the bad traders as soon as possible and let the good traders ride. Sound familiar? These firms realized that they could make more in commissions then what they would lose in losses. The model worked well for many years until volatility slowly came to a halt around 2003. Once volatility dried up, so did the volume. And with the volume gone, so were the commissions. Firms simply could not afford to take the risk of backing traders without the commission buffer. Game over.
Next up were the futures firms. With equities dying, suddenly futures became the big game in town. And they used a similar model to equity prop firms. Since futures are already leveraged, nobody wanted to take the risk of letting guys come in and swing for the fences, so most of these firms endorsed the spread trading model. They primarily traded the yield curve. By trading spreads, the commission income made sense and the risk traders were taking was more controlled on top of the fact that debt markets actually lended themselves well to spreading strategies. So once again firms could lean on commissions as well as rebates offered by the exchanges for providing liquidity to buffer against the losses they had to absorb from bad traders. Of course the bad news is, eventually volume began to dry up here as well and the same cycle begins to repeat itself.
This led us to where we are today. The pay to play model. Technology has just gotten to the point where it can do everything you can do faster, cheaper and it doesn't eat, require sleep and or need a bonus and healthcare benefits. It's pretty hard to compete with that. But there are firms out there that will let you try, it's just going to cost you. Some firms will let you come on board for 5k, others want 25k to 50k.
So why join one of these pay to play firms? There are several reasons. One of course is leverage and lots of it. Other reasons include lower commissions, better software and the ability to learn from others. Let me address this last point, the ability to learn from others. This is probably the last best edge available for newbie traders. The ability to sit next to and learn from other traders, particularly profitable traders. There is nothing better then gaining knowledge from those that came before you. It truly is as close to the holy grail as you are going to get. And I'm not implying that you are going to learn some secret method from these traders but rather you are going to learn a process. A way of looking at the market. You are going to get inside the head of other traders to see how they approach every trading day. Trading by yourself at home will never give you this opportunity.
Is discretionary trading dead? This is often asked on online forums being that all one sees in the job market is ads for high frequency algorithmic traders with the ability to program in c##. No, discretionary trading is not dead and will never go away. But it's also not where the opportunity is. The real opportunity is going to be on the programming side. Or on the financial services side allocating money to these high tech quant firms. In the last few years we have seen an explosion in 3rd party software. We have seen the emergence of trading blogs with content that rivals that of The Wall Street Journal. We have seen the emergence of niche sites that provide information in very clever and unique ways for the every day trader. Of course there is also no end to the get rich infomercials and red light-green light trading systems.
The deal now is, going forward, young men and women are going to have to work for it. If you really want to be a discretionary trader, you might have to get a night job. Or a day job while learning to trade markets over night. You are going to have to save your money and once you have enough capital, put it on the line and takes your chances. The success rate will be the same as it always has, low, very low. But the reward will be high.
