Proprietary trading firms (prop shops) have become more and more favorable among traders searching for the power of institutional capital, while staying away from numerous constraints related to personal account sizes. However, the fee structures designed by these firms can get really tricky and it does affect their performances and returns for sure.
What Is A Prop Trading Firm?
A proprietary trading firm offers traders capital in return for a cut of the profits. In contrast to most traditional investment companies, prop firms trade for profit using their continual trades of firm capital. These traders often get to use elite-level trading platforms, lots of bells and whistles in regard to research reports and other resources, and the ability to trade more massive positions than they would have been able to otherwise on their own.
Types of Fees in Prop Trading Firms
Prop trading is often considered the land of free money (it’s not)…the cost structure is traditionally a mixture between profit splits, account management fees etc. All traders considering joining the prop firm should fully understand these fees.
Profit Splits
The profit split is the most frequent fee and number one way for prop trading firms to charge their clients. This is the percentage of earnings that gets retained by the firm to slice off for providing capital and resources. The split of profits can be anywhere from 20% to 50% or even more, depending on the firm and well as experience and performance of the trader. For example, a trader earns $100,000 in profit on a 70/30 profit split. The trader earns $70,000 while the firm takes $30,000.
Account Management Fees
Many will charge account management fees, which are recurring charges for keeping the trader’s account. These charges could be fixed or based on the account size, with an example where a trader loses their trades and those charges come afterward from the balance of the trader. For example, an account management fee might be $500/month or 1% of the account balance annually.
Training and Education Fees
Most prop firms will provide you with training and learning so as to make such transactions more reliable. Some firms offer these resources for free, while others charge extra money for access to training programs, webinars, and one-on-one coaching sessions. Case in point: a company offering training for new traders who would charge $1,000 per year for all levels of training.
Platform and Data Fees
Factors that determine the success of a trade include trading platforms and market data. These services are charged to the traders through platform and data fees by some prop firms. These expenses differ according to the quality of the trading platform and the level of provision of the market data. For example, platform fees are going to be around $100 per month, and data fees could range anywhere from $50 to $200 depending upon where you get the data.
Bonuses and Penalties for Performance
Apart from profit splits, there are some prop firms which provide performance bonuses on exceeding particular profits. Alternatively, they may also fine their respondents for poor performance or breaking risk management protocols. Large bonuses and penalties can have a substantial bearing on a trader’s bottom line. E.g. a firm may offer profit above $50,000 in a month a 5% bonus or loss greater than X limit below which the proprietary trader receives only commission, trading expenses + monthly “cliff” deducted from book profits for use of the desk.
Intra-Day Performance and Portfolio Returns Implications
How prop trading firms charge fees can also significantly impact trader performance and overall returns.
How These Fees Change Results
Profit Splits and Motivation
Profit splits help align traders’ interests with the firm’s — they’re incentivized to trade well, after all, and it is clear that these can lead to higher take-home pay for traders. Put another way, if you have a 50/50 split on profits it will take twice as much profit for you to make the same income as someone with a 75/25 split. This can create more pressure, which will result in behaving riskier with trade decisions.
Account Management Fees and Money Management Costs
Fixed account management fees can be remarkably expensive, especially during slow periods for trading performance. When they calculate their full profits, traders have to also consider the costs in which this goes together. This is also likely to deter smaller traders as account management fees are high in comparison with the take-home pay of these types, which can be a substantial proportion.
Training and Development of Skills
Education: Training Investment so that Traders Become a More and (… or) For Profit-like Trader
Nevertheless, training is not cheap, especially for new traders who possibly have a high upfront cost already. Traders need to evaluate the future value of education as opposed to that of immediate money spent.
Platform and Data Fees, Operational Costs
Essentials for Trading: With trading, you require tools and data to give your best shot in the market which is possible only with some platform or data fees. While these fees are par for the course, traders should compare costs amongst various firms to determine who offers the most cost-effective solution. The fact is, high fees can literally eat into your profits (especially if you’re a high-frequency or day trader that uses more advanced platforms and real-time data).
Performance Bonuses & Penalties and Behavioral Effect
Performance-based bonuses are a strong motivational factor, pushing traders even more to reach further profits. But penalties for non-compliance can create a high-stress environment that has numerous negative effects and may lead to bad decisions and even more risk-taking. Traders should be aware of the particular conditions required for these bonuses and penalties, and how they relate to their trading strategies as well as tolerance to risk.
Assessing Prop Firm Fees With A CFP
Understanding Fee Structures at Prop Trading Firms
A CFP can provide proper clarification on the complex fee structures of prop trading firms along with advice.
How Your CFP Can Help
Cost-Benefit Analysis
A CFP can perform a cost-benefit analysis of the series of fees that come with different prop firms. This analysis is able to benefit trading by allowing traders to compare what the true cost of trading at each firm would be and make an informed decision based on how they trade.
Budgeting + Financial Planning
Help traders create a comprehensive financial plan that includes all trading expenses. This means forecasting account management fees, training costs or any other ongoing expenses and know what to expect out of pocket.
Risk Management
Trading requires risk management. A CFP can help traders build strategies and manage financial risk from trading fees and market volatility. This means budgeting for losses and contingencies.
Long-Term Financial Goals
Besides the immediate trading issues, a CFP can help traders link their trading activities to long term financial goals. This means long term investing, retirement planning, tax planning and proper diversification to generate profits.
Conclusion
Assessing the fee structures of prop trading firms is a must for any trader who wants to pursue this career. Knowing the different fees including profit splits, account management fees, training costs, platform and data fees and performance bonuses and penalties will help you make informed decisions. With a CFP, you can see how these fees affect your overall performance and investor returns and make decisions that support your financial success.
