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Prop trading – the basics

Prop trading – or to give its full title, proprietary trading – is where a firm such as OANDA invests its own funds for profit rather than using a client’s money. The primary goal is profit – rather than earn a commission from processing trades, the firm earns full profits (and losses) from any trades placed in the market.

OANDA’s approach to proprietary trading opens up this model for external traders to participate.Traders access virtual capital and trade it in real market conditions. OANDA uses this virtual trading to generate trading signals for our proprietary trading models to follow. When a trader’s virtual trades generate positive P&L in the trader’s virtual account, OANDA pays a share of this P&L to the participating trader as a real (not virtual) payout. This is because OANDA’s proprietary trading benefits from accessing these trading signals in our own trading decisions. 

As well as the opportunity to earn a profit share, prop traders also typically have access to the firm’s technologies and market data, which can help them navigate the challenges of trading.

How prop trading works

A prop trading firm allocates an agreed amount of capital to a trader to trade with. Prop traders generally have autonomy over how they then trade – they face the same challenges as standard traders. Prop traders use a number of different strategies for trading, including approaches such as arbitrage (including index, volatility and merger arbitrage), global macro trading, swing trading and day trading.

Risk management is a vital factor in any form of trading and prop trading is no exception. Because a firm’s own capital may be at risk, there will often be higher levels of scrutiny with regards to the activities of prop traders, and stringent conditions will usually apply. 

One of those is the maximum drawdown limit that the firm imposes on prop traders – if their trading account drops below a predetermined threshold, it’ll be suspended.

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How do prop trading firms and prop traders make money?

In a standard trading setup, a firm would derive its income on a commission or percentage basis from acting as a broker on behalf of its clients. The client is using their own funds to place trades – and that’s a major difference between a brokerage model and prop trading.

In the case of prop trading, the firm is using its own funds, so it earns 100% of any profits or losses that it makes. 

The trader makes their money from an agreed share of any profits that they make. In the case of the OANDA Prop Trader Challenge, the allocated funds are virtual – but the prop trader gets a genuine share of up to 90% any profits they make.

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Funding level

Prop trading usually gives traders access to a higher level of capital than they would normally have available for trading. This offers the opportunity for higher levels of profit.

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Technology and market data

Prop trading firms normally include access to their tools, technology and market data as part of their programs. These would usually be too costly for many potential traders.

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Low-risk learning

Trading can be challenging. Prop trading can offer learning opportunities for traders of any level as the cost for participating is limited to the fee the participant pays to take the challenge.

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Increased oversight

OANDA wants to make sure that the traders who generate signals are qualified for the program. Risk limits and rules are in place to make sure traders who qualify to become signal providers are producing usable, valuable trading information.

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Your income depends on your skill

Successful trading at any level depends on the skill of the trader. A prop trading firm may supply you with the tools and tech to help you build your strategies, but you have to evolve them and make them work.

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It might not be for you

Not everyone is cut out for trading. It’s a competitive environment and there’s a lot to learn.