Prop trading firms and the whole concept of prop trading are currently facing significant pressure.
Challenges, such as manipulation, trader dissatisfaction, and regulatory ambiguity, all contribute to reputational risks that further complicate already complex operations.
If you’ve read the industry news at least a couple of times over the past year, you’ve most likely seen reports on seemingly well-doing prop trading companies shutting down, some with a scandal on their hands.
So, as much as we’d like to say that the prospects of prop trading are bright, it is actually very uncertain. The industry is at a crossroads right now, and today we’re going to take a deeper look into what’s going on and see if there is, in fact, a future for prop firms.
Why prop trading is attractive
While not without its problems, prop trading remains attractive to traders for a number of reasons.
Traders greatly benefit from participating in the prop trading scheme.
- Easy entry for traders: Prop companies provide capital and infrastructure, allowing even the newest traders to start trading without investing personal funds. This eliminates the traditional financial barrier for entering the trading world and expanding possibilities for individual investors.
- High reward potential: Traders access significant capital and leverage, and they’re able to place larger orders and thus earn substantially more compared to trading with their own money.
- Low risks: When trading the firm’s capital, the worst that can happen to traders is elimination from the contest. They’re not risking their finances; instead, the risk is absorbed by the prop firm.
As for the prop firm, the model allows it to reap many benefits, including:
- Directly benefiting from the trader’s profitable activity.
- Access to top trading talent that can be hired or signed for a long-term partnership.
- Competitive edge gained through prop trading competitions.
The industry’s growing problems
It’s all fun and games until the notorious prop trading issues arise.
- Manipulated challenge completions: It’s not a secret that there are organised groups that exploit the challenge rules by coordinating hedging across numerous accounts to guarantee success. Prop firms are working overtime to uncover these networks of cheaters. Still, at most the only outcome of such investigations are more rigid and complicated rules for everyone that scare off honest traders.
- Unclear payout conditions: Payout rules are often complex and ambiguous, leading to numerous hidden aspects, including extra fees, profit splits, and last-minute changes to withdrawal policies. Lack of transparency has never helped build trust, and it instead causes confusion, resulting in disputes with traders that are often detrimental to the firm’s reputation.
- Online scrutiny: Many are sceptical of prop trading as a concept. With traders actively posting negative reviews and posts the second they aren’t satisfied with something (which they have the right to do), it instantly gets picked up by themed forums and media outlets, causing even minor issues to get blown out of proportion. Once public, whether fair or not, the criticisms slowly build up, damaging the firm’s reputation and deterring new participants.
- Regulatory constraints: Since the revival of prop trading a couple of years ago, this niche of the trading industry has been booming, which has naturally attracted regulators. For prop firms, a significant development in theory (as the trading industry as a whole needs better and stronger regulation)resulted in several mixed signals, laws, and rules that didn’t necessarily protect the parties involved, but created a layer of complexity in operations.
The trading world is not new to challenges, but in the prop trading sector, these issues have piled up quickly, imposing even higher risks to an already fragile industry.
Transparency as a survival tool
What can one do with all the problems we’ve just talked about?
Introduce and strengthen transparency.
Albeit not a miracle worker, transparency can and will elevate the prop firms and help them survive in the hostile environment that they find themselves in today.
- Build long-term trust
- Improve the quality of trader selection
- Cut down on disputes and complaints
- Boost trader performance
But what does transparency really mean?
- Clear and fair rules
- Public KPIs
- No hidden fees or fine print
- Realistic targets
- Genuine partnership with traders
Prop firms that implement all of the above will put themselves way ahead of the curve. This creates a positive image, user-friendly trading conditions, and makes them the good guys in the eyes of the regulatory body.
How technology helps prop firms
We probably don’t have to tell you that technology solutions are the heart and soul of any trading company, including prop firms.
Investing in a powerful and flexible technology stack is one of (if not the) top priority.
Innovative solutions that are built for prop firms cover every aspect of operations:
- Provide real-time analytics and monitoring
- Enable full audit trails and data logging
- Automated drawdown control
- Help detect exploitative strategies early
- Build a reputation as a trustworthy and transparent firm
Risk management for prop trading firms
When it comes to prop trading, risk management is primarily enforced through technology.
Timely and efficient risk identification and mitigation is a critical pillar of any prop firm. It allows companies to effectively deal with the increasing challenge coming from organised groups that engage in hedging abuse, undermining the integrity and profitability of the entire operation.
While risk management strategies and instruments aren’t able to keep prop firms protected in 100% of cases (it’s simply unrealistic to expect that from any strategy or technology), they’re still more than capable of minimising the risks and the aftermath of disasters.
- Real-time monitoring tracks all traders’ positions and can signal when maximum exposure thresholds, Stop-Loss limits, or some other pre-defined criteria are achieved, allowing the company to act swiftly.
- Audit trails and pattern recognition detect suspicious activities early on, before they cause significant damage, such as coordinated trading.
When it comes to risks in prop trading, staying vigilant and spotting vulnerabilities before they escalate is the key to safeguarding the company’s capital, reputation, and market share.
In addition to protecting the firm’s assets, an advanced and up-to-date risk management system, powered by robust technology, sends a signal to the market that your company is trustworthy, fair, and a haven for all traders.
Final thoughts on the future of prop trading
Despite all the issues and complications, prop trading isn’t really dying. It’s evolving.
Any fast-growing and rapidly developing industry goes through bumps. A spike in interest and FOMO led to an avalanche of prop firms launching, and huge crowds of traders were willing to jump on the latest trend, putting even more pressure on the new trading format.
We are currently living through a pivotal moment. The future will belong to those who are ready to embrace openness, adaptability, and technology.
The problems and complexities of prop trading won’t magically disappear, but the right mindset, coupled with the right tools, will help companies grow and build a sustainable future.
Tools for Brokers helps prop firms survive through the hardship and thrive in the new reality. If you’re curious about launching a prop firm or want to elevate your existing business, email us at sales@t4b.com.
