Proprietary trading, also known as prop trading is a trading approach. Here a financial firm, such as a bank trades directly in the financial markets. In this case, the company assumes the identity of a trader and will open and exit market positions for a profit.
A thing to know is that most financial firms earn from the financial markets by trading on behalf of clients. They earn a commission for their services. Prop trading has been around for a long time and boosts the associated company’s earnings.
To give you a better understanding of this approach, we bring you five things to know about prop trading firms.
1. Involved Companies
Several companies can engage in this form of trading. The common ones are commercial banks, hedge fund firms, and brokerage companies. You may find a department in the company fully dedicated to trading. The firm may employ professional traders, who put their speculation expertise to use.
A point to note is that a company exists as its entity; that is, it is like a person. It uses its funds or assets to get into the market. There are also so called “Recruiter Firms” which contract external partner traders, so they can fund their own strategy by gaining access to the equity of the company, but in exchange have to split their trading profits with the prop trading firm.
2. How Firms Do Prop Trading
The firm, existing as a legal entity, will use funds at its disposal to buy various securities listed in the trading market. It will buy a specified number of options, which it will, later on, sell to interested clients. It is a simple process, which can improve the company’s net worth.
Initially, the companies used to trade on behalf of their clients for a commission. However, in most cases, the commission is too little. Instead of doing the investment services on behalf of its clients, the companies does it for its benefit.
There are several trading strategies that the firms use, which we will see later on in this piece.
3. Prop Traders And Links To Inside Trading
Many traders believe that institutional firms have a competitive advantage in prop trading. Some of the advantages enjoyed include having sufficient investment capital and experts who help in speculation.
Then, there is the question of inside trading. The focus is mostly banks, which are parties in many company activities. For instance, if the bank is a party to two or more companies joining, it may use merger arbitrage to earn riskless profits.
This is a form of insider trading, which gives the involved firms an illegal competitive advantage.
4. The Use Of Online Trading Platforms
Courtesy of technological advancements in the financial investment sector, you can trade online. Prop trading has a spot in the online trading trend, through the various online trading accounts offered.
Some broker platforms have the company, corporate or professional account types, for prop trading. Signing up is very straightforward, with the requirements being relevant company documents.
Once signed up, the firms may get an assistant or account manager who helps in running and maintaining the account. Optionally, the firm can use its homegrown traders for the task.
5. Strategies The Companies Rely On
As a pro trader, you understand that your chances of a profit are as good as the trading strategies applied. Prop trading firms use many strategies for a successful trading session. The common ones include global macro trading, index arbitrage, merger arbitrage, fundamental analysis, order flow approach and many more.
Securities dealt with are bonds, stocks, currencies, and commodities. Depending on the company’s financial goals, it may opt for long-term or short-term trading approaches.
Prop trading refers to firms getting into the financial investment scene for profits. It is a legit approach, as we can see from this article. Look at the highlighted points on what to know about this trading form, to improve your trading knowledge and sense for professional market environment.