Five q's to ask before becoming a prop trader

Last month  @tradernickfx and @austinsilverfx and I discussed the enormously popular retail prop trading industry.  Should you audition for one of these firms? That’s subject for another column, but today I want to deconstruct the five key factors that will help you choose wisely if you do go down that path.

Over the past few years retail prop firms have blown up in popularity taking over the margin trading industry by offering traders every enticement imaginable to audition for a chance to “trade their money”. Of course there are more than a few scammers in the mix, but there are also many well established firms that have been paying out profits on a monthly basis for years. So assuming you are working with a legitimate firm - what are some of the factors that you need to consider?

Time limit versus no time limit offers

The easiest way for me to make you fail a trading audition is to put a time limit on your performance. That’s why so many prop firms make it the very first condition of their audition process. Putting a time limit not only forces the trader to gear up higher than is prudent in order to generate return, but will also force the trader to enter the market simply because he needs to beat the performance deadline rather than because the setup is there.  So no time limit firms are clearly better because they allow the trader to trade at their own pace.

The ability to hold positions over the weekend

If you are a swing trader the ability to hold trades over the weekend is a key benefit to seek. Unfortunately very few prop firms offer such terms because of the highly volatile nature  of the financial markets. No one wants to be exposed to gap risk especially in any highly levered position. This is not a deal killer as   a swing trader can simply re-establish the position Sunday night but should the gap move go your way those profits would be lost.

Reasonable Risk Reward terms

Most prop firm auditions require a 10% return with no greater than 5% drawdown. That’s a reasonable structure that basically asks you to generate 2 units of profit for 1 unit of risk. Anything tighter than that is unrealistic and really skews the odds of success against the trader. 10% up against 5% down is hard enough - don’t accept anything harder.

Wide variety of instruments

There are basically four primary instruments that are traded in the retail prop space - FX, equity indices such as Nasdaq, Dax, and Dow Jones, commodities such as metals and oil and crypto. Most of the firms will offer you at least 3 out of the 4 major markets. But some will restrain you to only one. If you are a specialist in that one market that may be fine, but for traders who want to seek opportunities far and wide - variety is not only the spice of life but is also the necessity for profit.

Favorable Spreads

This frankly took me by surprise as I assumed that in our highly integrated, highly competitive global markets spreads have basically been whittled down to 1 or 2 points. That’s usually the case, but not always and any prop firms that charge 3 or 4 points spreads on anything but the most volatile FX pairs or crypto are essentially setting you up for failure. Trading, especially day trading is a game of millimeters and a 2 point spread versus a 4 point spread could mean a difference between a 40 point win and a 40 point loss. Do that a few times during your audition process and you won't last a month before blowing out. 

Last but certainly not least is the need to take the money and run. Always cash your profits with the prop firm and never leave them with the “house”. Tempting as it may be to build up your account for a larger stake, the events of the past week teach us that a bird in hand is always worth two in the bush.