Great Article on Prop firms- Bright, Echo, Maverick Trading, SMB, etc.

robbmickey

Junior member
11 0
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.
 

robbmickey

Junior member
11 0
Part 2

that's some great points. I like to see prop as an alternative to retail trading for those who are willing to take the risk for the additional benefits. It does require experience and capital to be profitable. here is a great article on prop vs retail accounts:

By: Adam Watson, V.P. Business Development

Many newcomers to stock trading cannot tell the difference between a proprietary trading firm and an online (retail) broker. When deciding to open an account, traders make their comparison of brokers based on the relative cost and the products offered, but more often than not they fail to realize that the products are not exactly the same. This article seeks to shed light on the mechanics of a prop trading account and educate traders about the differences between the two options so that one can compare them more effectively.

The analysis has been provided in six key areas: software, rebates, fees, buying power, education and short locates (availability of hard to borrow securities). These are the areas in which the two are most distinctively different and are rightfully the most common factors considered in this decision. You as a trader will place a different emphasis on particular categories as you consider whether retail or prop is best for you.


Software

Retail – Retail brokers typically offer the ability to execute trades on their website. Most also offer their own trading platform at a monthly cost to the trader. This fee may be waived if you meet their minimum requirements for account assets.

Prop – A good prop firm will offer traders a choice between a few different direct access routing programs. A trader’s platform provides the ability to execute and monitor transactions quickly and effectively. A proprietary platform will have direct connectivity to the exchange matching engine. Hot keys are also a must have for intraday traders and are a feature offered in proprietary software, but not often that of retail firms. Most proprietary trading platforms provide access to more in depth real-time market data such as NASDAQ’s Totalview, ARCA Book, NYSE OpenBook, BATS and Direct Edge Books, although some of this data may come at an additional cost. Greater market depth and breadth can assist the trader in making better trading decisions on very active and heavily traded securities in real-time.


Rebates

Rebates refer to the compensation that ECNs provide to traders who add liquidity to the market. Most ECNs give rebates to traders who add liquidity and charge a slightly higher fee to traders who remove liquidity from their market center. This is a basic ECN business model, although there are a few ECNs that are structured differently.

Retail – In the vast majority of cases, retail firms do not pass on rebates to their traders. The online broker will most often route the flow to a low cost exclusive destination which does not cost extra and is not often directly to an exchange. If a retail trader chooses to route to a particular ECN, the additional fee on top of their flat commission rate may be passed through to the trader.

Prop – Traders who trade at a proprietary trading firm get the advantage of benefiting from the widely adopted “taker-maker” model that most exchanges offer. Traders who add liquidity will receive rebates for doing so in accordance with that exchange’s rates (which can be as high as $3/1000 shares). This can be a substantial source of revenue for the prop trader and will also influence his/her decision of which route to use.


Fees

Retail – The fee structure for retail firms will vary from shop to shop and the industry is highly competitive. One firm may offer no account transfer fees while another may advertise no inactivity fees. Still another may not charge for wires, but they may make this up in their commission structure. In general, retail firms have a flat, per trade commission rate that is charged. There is also usually a software fee for the platform unless you meet certain minimum asset requirements or if you are a very active trader. Some other incidental fees that you may incur are those that have been mentioned above.

Prop – Proprietary trading firms are able to offer more competitive commission and transaction fees than the online broker. Proprietary firms typically use a per share structure with breakpoints for decreasing your commission as your volume increases. This is often a direct benefit to intraday traders who have a high number of trades per day.

All prop firms charge a software or desk fee which goes to pay for the data and order entry software that the firm uses. Some offer this software “at cost” to their traders and some charge a premium on top of their cost. The variety of routes offered directly affects the desk fee as well, so ask your prospective shop about the routes available when talking about desk fees. For some traders, more routes is more value added.


Day Trading Buying Power

Retail – In retail accounts, your buying power is THE LESSER OF the equity in your account divided by .30 (the 30% minimum global margin requirement for equities) OR your SMA multiplied by 2 (which satisfies the Regulation T requirements for equity purchases). For day traders, you must have at least $25,000 in equity in order to do more than three round trips (day trades) in a rolling five business day period (FINRA Rule 2520). Outside of this model, certain accounts may be eligible for portfolio margin.

Prop – With a prop firm, your buying power is determined by the firm you’re with and the risk capital deposited. Some traders may be fully backed by a firm (true prop) in which case they can expect the firm to take a portion of profits to compensate for the risk taken. Many traders find trading prop more advantageous as they can trade a lot more capital that they would have access to in a retail account.

Day traders with less than $25,000 are prime clients of prop firms as they are able to trade freely without worrying about the minimum equity requirements enforced by FINRA Rule 2520. This is because most prop firms are set up so that traders trade sub accounts of the firm, but the firm “hits the street” as one large account.


Education

Retail – Many retail firms have educational information on their website. The breadth, depth and level of educational materials vary from firm to firm. The material is usually in the form of suggested reading, archived lessons and, occasionally, trading seminars.

Prop – Offerings for training in the prop field are highly sought after. Many traders who are beginning their trading careers look to prop firms with advertised training programs. Be cautious of firms that charge for educational classes and then provide firm capital for you to trade. Some of these firms are modeled to generate revenue from training which can cause a conflict of interest as their incentive to see traders last in the long run is greatly reduced. When a trader joins a prop firm and deposits risk capital, all compliant firms are required to hold your deposit for 12 months. Afterwards, the trader may receive his/her deposit back. In short, be aware that if a firm charges for training they may be trying to avoid the lock up period so they can treat it as revenue immediately.


Shorting/Locates

All traders, prop and retail, are subject to Regulation SHO which governs short selling in US markets. Traders must have located shares that they wish to borrow before selling short. Some stocks may be on the threshold list or “hard to borrow” list and may not be available. This list is updated every 24 hours.

Retail – If a retail trader would like to short a stock on the threshold list, there may be little that can be done to locate additional stock intraday and an opportunity may be missed.

Prop -Traders with a prop firm may submit locate requests before and during market hours in order to locate additional shares of stock on the threshold list.



As it happens, most traders begin trading in retail accounts due to their accessibility and pervasiveness in the investing community. Too many traders are unaware of the options available to them when it comes to cost structure, service and performance. It is my hope that this article will dispel some of the mystery and stigma from prop. Looking at these six areas, you can better determine if your style of trading is more suited for a prop account, or if you would be better off opening an account with a retail broker.

When choosing a firm in either category, research is paramount. Make sure your broker or trading desk has a sound reputation and make sure to ask the right questions. Talk to traders or read reviews on forums and trading websites. The better informed you are from the onset, the better your experience will be and the more comfortable you will be doing business with them.

Happy trading.
 

k-nau

Newbie
4 0
I have traded at both Bright and Echo and found it to be better than trading on my own. The additional capital is always great and having the risk controls is nice too. I was happy with both but I like Echo a little better
 

sharanki

Junior member
44 1
Great Articles! I never understood why everyone doesn't trade prop if they are going to trade at all. Maybe because of the "costs" involved as we all know there are some cheap people out there. Who wouldn't want to put up a couple thousand dollars to get an additional $30,000 to trade with? Yes, there are costs but it doesn't make sense to me not to take advantage of OPM. Why take all the risk? If you have $20,000 to trade with, put $5,000 with a prop firm where they will likely let you trade $25,000-50,000 and keep the rest in a personal trading account.
 

tita

Junior member
38 0
Thanks for posting those articles, robbmickey.

Has anyone come across any that applies specifically to the forex market?
 

soccerscott

Newbie
1 1
I don't really see the advantage to trade with a prop firm if you are an established trader with a couple good years of earnings behind you. It seems like most places want you to trade a lot more than you probably should.

However, I guess it makes sense for someone getting started to be part of a group to trade with while they practice their strategies. After they get solidly profitable, it looks a lot less beneficial and they should just trade on their own.

Or they could move all profits out of their prop account at the end of each month into their personal account and just keep the minimum to access the prop firms extra capital. Then, they wouldn't have to share profits with their trading earnings from their personal account and could trade two accounts until they were well enough funded to trade on their own.
 

k-nau

Newbie
4 0
Hi Everyone on this thread. I am looking for some different prop firms to research. I am already trading at Echo but I feel like I am on my own island. Here is what I am looking for:

1) I want to trade remotely
2) I want to feel like part of the group
3) I want to have people to talk to during the day
4) I want to trade options and futures
5) I want under .005 per share and .50 per contract
6) I want at least an 80% profit split

If anyone can give me some guidance or direction I would appreciate it.
 

flemming

Junior member
20 0
Hey K-Nau.

I am looking into two firms. My buddy trades at Maverick Trading and I know he loves it and is always online chatting and sitting in on trading sessions. But, I have no idea what he is paying in commissions or what his profit split. If you PM me, I will ask him and send it to you. I am also looking into VTrader in San Francisco. They are set up awesome for the style of trading I do and give me access to all asset classes. The only negative is the 100K minimum initial buy in. I am OK with it but I know it is prohibitive for alot of people out there.
 
 
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