What is proprietary trading and how do prop firms work?

What is prop trading?

Proprietary trading, commonly referred to as prop trading, describes the practice where traders engage in trading activities using the capital of a prop firm or financial institution rather than their own capital. These traders participate in a range of financial markets and use various financial instruments, including shares, options, futures, and contracts for difference (CFDs). The primary goal of prop trading is to generate profits for the institution using the capital allocated by the firm.

While some businesses engage exclusively in prop trading, it is also practised by:

1. Investment banks that have desks specialising in proprietary trading. Banks benefit from having extremely valuable information and order flow visibility. However, prop trading within banks has become heavily regulated since the 2008 financial crisis.
2. Hedge funds that trade their own funds as well as managing funds for their investors.
3. High-frequency trading firms that also act as market makers.
4. Commodity trading firms, such as Glencore, Vitol, and Trafigura, who trade commodities on the physical and futures markets.

What is a prop trading firm?

A prop firm is a company that provides its traders with access to capital. In return, the traders share a percentage of the profits they generate with the company.

Individuals face many hurdles on their journey to become professional traders. While a lack of sufficient capital is the most obvious one, they may also lack access to technology, market data, and tools. Prop firms can help skilled individuals propel their trading careers by providing capital, training, and general support.

The setup of prop firms varies significantly. Some prop trading companies have physical offices and provide a desk for their traders. Others operate entirely remotely, accepting traders into their programs from across the globe.

If you are looking to choose a prop firm, refer to our comparison of the eight top proprietary trading firms.

What is a prop trader?

An individual who trades using the firm's own funds instead of client funds is known as a prop trader. To make revenue for the company, they typically participate in speculative trading, which can involve both short and long-term strategies.

Proprietary trading firms typically allow their traders autonomy in making trading decisions. However, they establish a strict limit known as the maximum drawdown level. If a trader's losses reach this predefined threshold, the firm will intervene and suspend the trader's trading activities to mitigate further financial risks.

Prop traders make all or most of their income from splitting profits they generate in financial markets with the prop firm that provides the capital.

While prop traders face the same market challenges as independent traders, they benefit from institutional capital, technology, and direct interaction with other skilled professionals.

How does prop trading work?

When a trader is accepted by a proprietary trading firm, they are allocated a certain amount of capital to trade with. The size of this capital allocation, as well as the proportion of profits the trader is entitled to keep, varies depending on the trader's level of experience and their track record.

Prop traders employ various trading strategies, ranging from short-term trading to swing and position trading. Similarly, traders may use fundamental analysis,  technical analysis or a combination of the two when evaluating markets.

While risk management remains critical, trading on behalf of a prop firm is subject to stringent risk parameters and increased scrutiny to limit the firm's capital exposure to potential losses.

How do prop firms work?

To explain how prop firms work, we will use a hedge fund analogy.

Hedge funds rely on clients who provide the company with capital. The fund managers ultimately answer to their clients, who receive an average of 60-80% of the profit generated.

Prop firms, on the other hand, don’t take on clients as investors. Instead, they use their own corporate capital to generate profits in financial markets. This allows them greater freedom, flexibility, and the opportunity to keep a larger percentage of the overall returns.

For traders looking to access prop firm capital, the most common route is through a funded trading account. For a detailed breakdown of how funded accounts work and how to get one, see What is a funded trading account.

Prop firm business model: How do prop firms make money?

Prop firms generate revenue through several streams, depending on their structure and operational model.

Profit sharing

The primary source of revenue for most prop firms is a share of the profits generated by their traders. For example, a trader that generates $100,000 in profits during a certain period and has an 80/20 profit share agreement will receive $80,000, while the remaining $20,000 goes to the firm. While the trader keeps the larger share, the firm benefits from deploying capital across a large number of traders simultaneously.

Axi Select follows this model exclusively, meaning its interests are directly aligned with trader success.

Evaluation and challenge fees

Many prop firms charge traders a one-time or recurring fee to participate in an evaluation or challenge before receiving funding. This has become a significant, and for some firms, primary revenue stream. Traders pay the fee regardless of whether they pass the challenge, which means firms with high failure rates can generate substantial income from evaluation fees alone. This is why evaluating a firm's business model matters: a firm that profits mainly from failed challenges has different incentives than one that profits primarily from successful traders.

Axi Select does not charge any evaluation or joining fees, removing this potential conflict of interest entirely.

Subscription and membership fees

Some firms charge ongoing subscription or membership fees to maintain access to the program, trading tools, or educational resources.

Education and technology

Some prop firms, particularly those with physical offices or established training programs, generate additional revenue by selling educational courses, providing access to proprietary software, or licensing their trading infrastructure.

How do prop traders make money?

Prop traders make money by earning a profit share, a percentage of the profits they generate using the firm's capital. This is their primary source of income.

The percentage a trader receives varies by firm and program. Most prop firms currently offer profit shares ranging from 80% to 100%, though the conditions attached vary significantly. Firms offering higher splits often operate on simulated accounts and charge upfront evaluation fees, meaning traders risk their own money before ever seeing a payout.

Axi Select, by contrast, offers up to 80% on a live trading account with no joining fee, meaning traders keep a share of real profits from day one, without any upfront financial commitment.

Beyond the standard profit share, some firms offer commissions for referring new traders to the program.

Advantages of prop trading

Prop trading can provide individual traders with several distinct advantages:

1. Maximising profits: Talented traders may lack the funds to properly scale up their operations. To illustrate, it is incredibly difficult for a trader to generate a significant return on a $200 account, particularly if they practise proper risk management. Prop firms offer these skilled individuals the chance to establish themselves as professional traders and generate substantial profits.
   
   
2. Autonomy: Although each prop firm implements its own risk management guidelines to guard against catastrophic losses, traders typically enjoy a great deal of latitude and discretion in how they trade their allocated capital.
   
   
3. Accelerated learning curve: Working alongside other talented traders and seasoned professionals provides an educational environment and the opportunity to build meaningful connections.
   
   
4. Technology: Access to institutional technology can be costly. Expenses for data feeds, professional charting software, live news feeds, and expert insights add up quickly, while high-end tools like Bloomberg terminals require significant investments. Proprietary trading firms provide their traders with these technological resources, enabling better-informed decisions without the individual cost burden.
   
   
5. Lower risk: The trader assumes significantly reduced personal financial risk because the capital is entirely provided by the prop firm.

Disadvantages of prop trading

While there are significant benefits to prop trading, it is not without its drawbacks:

1. Increased pressure: If you are purely trading your own funds, you ultimately answer to no one. However, trading with the capital of a prop firm comes with responsibility, and the firm will expect the traders to hit their performance targets.
   
   
2. Lack of stability: Prop firms typically have very little patience with prolonged underperformance, and lagging traders can be quickly removed from the capital allocation program.
   
   
3. Upfront fees: Many programs require traders to pay a membership or joining fee and pass rigorous challenges in order to participate. This can create an unnecessary financial burden and a stressful introductory experience. 

How to get started with prop trading

The entry requirements to join a prop firm vary significantly. For example, a traditional prop firm whose traders are based in a physical office, equipped with advanced institutional infrastructure, and supported by extensive internal training will have strict entry requirements, a long screening process, and a limited number of open positions.

On the other hand, remote prop companies that focus on providing funded accounts online make it much easier for talented traders to join. In a typical remote setup, a trader pays a joining or subscription fee before participating in a challenge or assessment period. They must demonstrate their trading abilities on a demo account while adhering to strict maximum drawdown limits and profit targets. If the trader successfully completes the challenge, they are admitted into the program and become eligible for future funding increases.

Introducing Axi Select

Axi Select is a unique capital allocation program designed to help traders achieve their long-term trading goals. Unlike many other programs, joining Axi Select is 100% free of charge and does not require paying any registration, evaluation, or membership fees at any time.

Skilled traders can keep up to 80% of the profits generated and benefit from advanced trading tools, market analysis, and educational content as they progress through the six stages of the program.

Axi Select provides each participant with an Edge Score. This metric helps traders track their progress and automatically advances them to the next stage of the program, unlocking additional funding. The Edge Score takes the following components into consideration:

• Skill: Your ability to generate profits while managing drawdowns.
• Risk: The consistency and quality of your risk management.
• Consistency: Your ability to consistently generate positive returns over time.
• Experience: Whether you meet the minimum criteria for demonstrating credible, steady trading experience.

How is Axi Select different from other funded programs?

* Other fees and minimum deposit apply

This information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. It has been prepared without taking your objectives, financial situation, or needs into account. Any references to past performance and forecasts are not reliable indicators of future results. Axi makes no representation and assumes no liability regarding the accuracy and completeness of the content in this publication. Readers should seek their own advice.