What is Proprietary Trading?
Proprietary trading is one of the most merit based trading careers. Its objective is simple: Make as much money as possible on behalf of your firm, and you’ll earn a percentage of it.
The opportunity to generate higher earnings much earlier in your career than when compared to other trading careers or investment banking jobs makes it an attractive proposition for hundreds of wannabe traders.
But what exactly is it? We’ll define the trading itself, as well as the benefits and describe an average day in the life of a proprietary trader.
What is Proprietary Trading?
Proprietary trading, often known as prop trading, is a type of trading where trades are made on behalf of firms, banks and institutions.
Traders buy and sell financial instruments like bonds or commodities and execute two different types of trades to make profits. These are called either directional or market making trades.
If a proprietary trader makes a directional trade, they bet that a trade security’s price will fluctuate either positively or negatively.
On the other hand if a proprietary trader makes a market-making trade, they act as both the buyer and seller of the trading securities and aim to make a profit on the difference between the price the security was bought at, and the price at which it was sold.
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As well as these different types of trades, proprietary traders use a variety of different strategies in order to successfully make profits. These could include arbitrage strategies (making a profit on the difference between purchase and sale prices) like index arbitrage, merger arbitrage and volatility arbitrage, as well as global macro-trading.
In addition to trades and trading strategies, prop traders benefit from access to a huge range of sophisticated software and tools. These collate large quantities of information needed to help them make informed decisions.
What are the Benefits of Proprietary Trading?
Proprietary trading provides many benefits for both traders and financial institutions.
For traders, proprietary trading negates the need to trade their own money which makes it a safer option for those just starting out in their trading career. Firms meanwhile can enjoy notably higher quarterly and annual profits from successful prop trades.
Other benefits include:
Proprietary trading firms can enjoy 100% of the profits of proprietary trading. When trading on behalf of clients or acting as a broker in banks, the firm only receives very small revenues made from commissions and fees. In proprietary trading this is removed, and the firm has access to the maximum amount of profit generated from a trade.
Firms can become influential market makers through proprietary trading. Firms that deal in specific types of securities can provide liquidity for investors within those securities by purchasing the securities with their own resources, and then selling on the securities to investors at a later date.
What is the Difference between Prop Trading and Hedge Funds?
Proprietary trading is quite often mentioned in conjunction with hedge funds. Whilst hedge funds can include proprietary trading desks that use a particular firm’s portion of the overall capital controlled by the fund, there are notable differences between the two.
To begin with hedge funds raise capital from outside investors and then invest that clients money into the financial markets. Hedge funds then receive a portion of payment once they have generated a gain on the investment.
Proprietary traders on the other hand use the firm or institutions' own money to invest in the financial markets. Prop trading firms also retain 100% of any returns generated, with a percentage split given to the trader.
Other differences include:
Proprietary trading partners are able to take much higher percentages of any profits earned for themselves.
Proprietary traders' smaller capital base means that extremely high annual returns (in the region of 100%, 200%+) are possible to be earned in a shorter amount of time.
Proprietary trading firms are more independent, offering them the freedom to operate in much smaller and more niche markets that larger, institutional level trading firms avoid. This leads to generating profit in potentially untapped markets.
What is a Proprietary Trader’s job like?
On average, a proprietary trader will work around 50 hours a week though this can vary depending on firm, experience and seniority.
The hours are relatively similar to a normal 9-5 position, but by nature the role is much more intense and pressurised.
However, trading roles do not stick to conventional hours due to the nature of their work. This can be a huge benefit for some. Your hours worked don’t necessarily matter: Profits and losses do.
Traders should also expect to work out of normal conventional hours, depending on their geographical location in relation to the opening and closing hours of their chosen markets.
For example, if a trader lives in London, but has a firm that covers both European and U.S markets, they could expect to spend around 12-14 hours of their day working. This is to take into account waking up, working European hours, taking a break and then trading across the U.S markets which run 5-6 hours behind.
Junior traders quite often need to stay behind once the market has closed to do wrap-up work too. Wrap up work could include reporting profits and losses to management and charting entrances, exits and strategies.
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The average proprietary traders day will look something like this:
The day will start with a morning meeting to go through overnight happenings. These include market moves or adjustments, and any overnight world events that could impact the markets.
Traders will then read, assess and evaluate the news events, before using this information to begin trading once the market opens.
If a trader is in a discretionary role, they’ll spend time talking with other traders to exchange ideas as well as buying and selling.
If a trader is in a quantitative role, they’ll spend time modifying trading parameters and working alongside developers and analysts to create new, effective strategies.
Proprietary traders experience the busiest parts of their day when the markets they are trading on open and close. In the middle of the day it’s common to experience lulls which are usually dedicated to further reading and strategising.
At the end of the day once markets have closed, everyone will gather to discuss and dissect the major trades and overall market activity, and plan ahead for any expected events during the week.
So, after our comprehensive look into proprietary trading, has it left you wanting to get started?
If so, our Alphachain Trader challenge might be your next step.
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