Prop Trading – Chance or risk?

In this article we will discuss the question of what prop trading (proprietary trading) is and the difficulties that arise for a prop trader.

What is Prop-Trading?

What does a Prop-Trader do and with whose capital does he trade?

General Definition Proprietary Trading

Prop-Trading is the abbreviation for the English term Proprietary Trading and means proprietary trading in the analogous German translation. Prop-Trading in itself is not a particular trading style, but is primarily concerned with legal definitions.

The most important facts in brief

A trader in a fund legally trades with foreign capital; a prop house works with equity. If you trade with the money of the Prop House, it is debt capital for you.

Trading with borrowed capital

When an investor buys a fund from a fund company, he transfers the money for the fund unit to the company. The fund company thus acquires ownership of the money and can invest it in accordance with the provisions of the fund catalogue. It is now important that the fund company does not become the owner of the money at any time.

A fund is considered a special asset, the money in the fund must be kept separate from the equity of the fund.

Trading with equity capital

If an investor (or trader who trades in the house and deposits money himself) acquires shares in a Prop House, he transfers the money to the Prop House.

The Prop House is now in possession of the money and can work with it. Here is the difference to the fund. From a legal point of view, the money is now the equity of the Prop House.

So the trader in a Prop House trades with “equity”. It is important to understand that from the personal point of view of the trader it is of course debt capital, but from a legal point of view it is equity.

Thus, the Prop House only trades with its own capital and thus conducts “own trading”.

Note

The term “Prop House” is not legally defined, it is simply the chosen legal corporate structure of the company that acts as “Prop House”, e.g. a Limited.

What is a Prop-Trader?

What does a Prop-Trader do and with whose capital does he trade?

Definition Prop Trader

A Prop-Trader is a person who trades with a part of the capital of a Prop House.

Is Prop Trading allowed in Germany?

You can read again and again that prop trading is allegedly prohibited in Germany, which is not true. Anyone who meets the relevant conditions can obtain a proprietary trading license from BaFin and start a Prop House.

That there are no Prop-Houses in Germany is due to German social security law.

Difference of the legal systems

Most Prop Houses are located in the USA and in England. Anglo-American law (USA, England) differs fundamentally from continental European law (Germany) in many points, which has historical reasons.

Independent Contractor

In Anglo-American law there is the so-called “Independent Contractor” (IC).

The IC is a person associated with a company who is subject to the instructions of the company without being an employee of the company.

Almost all prop traders employ their prop traders as IC.

Danger of pseudo self-employment

This is exactly the problem, because according to German law this construction is a pseudo-self-employment. Fake self-employment is punishable in Germany and causes massive problems for the fake self-employed (The Prop Trader is liable for social security contributions to the German state).

If you are interested in the subject of prop trading, it is strongly recommended to get advice from a lawyer familiar with the subject.

Trying to save on the fees for the advice can be very expensive, because as an IC, in cases where the state cannot recover the money from the client, you are liable to the German state for all social security contributions.

Different Types of Prop Houses

Prop Trading is not equal to Prop Trading

Different business models of Prop Houses
In this article so far we have only discussed the type of “prop trading” in which a prop house provides you with capital.

It is important to note that this type of Prop-Trading is the lowest level, where mostly the so-called “recruiters” are active.

Recruiter

Recruiters are aimed at everyone, whether you have experience as a trader or not is completely unimportant.

The business model of the recruiters is based on the fact that as many traders as possible go through an “admission phase”, which is always subject to a fee.

Recruiters usually force their traders to daytrade.

The conditions for obtaining capital are extremely hard and usually only beatable with pure daytrading/scalping.

Companies in this category have sometimes very high marketing budgets and are therefore often linked to “info pages” on the subject of trading (no wonder, the commissions one can receive as a website operator are not exactly tiny…)

These houses are characterised by the fact that they are relatively well known in the retail scene. The retail trading scene is also the actual target group of these companies.

A large proportion of all traders do not “survive” the recruitment phase of the recruiters.
A large proportion of all traders do not survive the admission phase. Coincidentally, however, with almost all recruiters you have the opportunity to try as often as you like.

And so many traders, hoping to fulfill the conditions of the house sometime, pay high “admission fees”, sometimes for months. Exactly this “hope” of the traders is what the providers live on in the end. Most recruiters earn their money not with the profit split between trader and prop house, but with the admission fees.

Five rules for trading with recruiters:

Starting such an admission process with a recruiter only makes sense under the following five conditions:

  1. You have no less than a minimum of $50,000 (better $100,000) trading equity.
  2. The conditions you have to meet with each recruiter are in line with your strategy.
  3. You have already fulfilled the conditions several times on demo accounts (preferably those that actually simulate the order book behaviour of the stock exchange).
  4. You can fulfill the conditions very quickly (otherwise you will pay admission fees for months).
  5. You do not plan any further trading activities of your own outside of the Prop House, except in the long-term area.

The price data problem.

Grade five point is extremely important. If you manage to get a contract from a Prop House, you are considered a “trading professional” on the stock exchange. This means that in order to get quote data from the stock exchange, you now have to pay the “pro fees”. This is a big difference to the “retail fess”.

For example, the Level II price data fees for the CME, CBOT, COMEX and NYMEX exchanges are only $15 per month for private traders. The pro fees are $110…per exchange.

So we’re talking about a price difference of $425 a month.

If you want to trade both at your Prop House and in a private account, you will have to pay for the expensive data twice (in case you want to trade the respective exchanges).

Trading with recruiters makes no sense to most traders.
The problem with the price data alone means that you have to be sure that you can generate stable income from trading in order for it to make sense to incur these costs.

Prop-Trading makes sense for experienced traders

Prop-Trading makes much more sense than a recruiter in a completely different area, namely if you have been a successful trader for a long time (ideally 2-5 years) and trade with accounts of over $100,000. In this case you have the possibility to turn to Prop Houses that do not target everybody.

Your advantages as an experienced trader at a Prop House:

When you join such a house, your advantages can be

  • Access to stock markets to which you normally have no access as a private trader.
  • In some cases significantly reduced transaction fees
  • Access to professional research.

The best prop houses are not for everyone.
The prop houses in this category are characterized by the fact that they do not care about being known, have no marketing budgets and are completely unknown in the retail trading scene. The retail trading scene is not the actual target group of these companies.

Conclusion

Prop trading is a very popular way of trading in England and the USA, because as a trader you do not (necessarily) have to risk your own capital and can usually trade with much larger sums than you have available.

This kind of trading is largely unknown, which is because the way prop traders are employed collides often with social security law.

Any person with the main residence is strongly discouraged from starting a career with a foreign Prop House without first discussing the feasibility with a lawyer. Regardless of this legal problem existing, it is important to note that there are different forms of prop trading.

While the recruiters address themselves to everybody and usually only sell a dream (there are maybe a handful of really good recruiters in the world), other prop houses primarily address experienced private traders.

Basically it must be considered very well in advance whether it makes sense to join a Prop House or not.

From our experience, the answer to this question is probably no rather than yes for most people with a German primary residence, who do not have at least a trading capital of $100,000 and several years of trading experience.

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