Proprietary trading and retail trading are both buying and selling financial instruments. They differ in capital, tools, fees, oversight, and compensation structures. Let’s get into it.
Capital
Proprietary trading firms give prop traders a funded account which can be thousands to millions of dollars depending on the trader’s experience and performance. Retail traders use their own capital and are limited by their funds. This difference in capital can make a big difference in a trader’s ability to take on bigger positions, diversify their portfolio and withstand market volatility.
Prop traders can make more money due to the extra buying power but they also have more pressure to perform and manage risk. Retail traders have more control over their funds but may be limited in their trading strategies and returns due to their smaller account sizes. However retail traders can grow their accounts over time and increase their trading capacity as they gain experience and profitability.
Tools and Technology
Prop traders have access to top of the line trading software, high speed internet and advanced market data feeds. These tools can give them an advantage in executing trades fast and efficiently. Retail traders on the other hand rely on public tools and resources.
The technology provided by prop firms can include algorithmic trading platforms, custom built charting software and real-time market data from multiple exchanges. This can help prop traders find opportunities faster, execute trades with minimal latency and monitor their positions better.
Retail traders can have access to similar tools through their brokers but the quality and depth of these resources can be vastly different. However many retail trading platforms have evolved to offer advanced features and competitive pricing so the gap between prop and retail traders’ access to technology has narrowed. Ultimately it’s up to the individual trader to use these tools effectively for their trading strategies.
Commissions and Fees
Prop trading firms usually have lower commissions and fees than retail brokers. This is because prop firms make money from their traders’ profits not from commissions. Lower fees can make a big difference to a trader’s overall profitability.
Prop traders benefit from their firm’s economies of scale. With high trading volumes the firm can negotiate better rates with exchanges and data providers. This means big cost savings for prop traders who can then allocate more of their profits to their personal compensation.
Retail traders on the other hand are subject to the fees and commissions of their brokers which can vary wildly depending on the broker’s business model and the trader’s account size. High fees can eat into a retail trader’s profits especially if they are trading frequently or with smaller position sizes at high commission rates.
However many retail brokers now offer competitive pricing and even commission free trading for certain assets so retail traders can minimize their trading costs. In futures trading for example there are many discount futures brokers that offer low commission rates for high volume traders.
Rules and Oversight
Prop traders are subject to strict risk management rules and oversight by their firm. They may have to follow specific trading strategies, risk limits, rules and capital allocation guidelines. Retail traders have more flexibility in their trading approach but are still subject to the rules of their broker and regulatory bodies.
Prop firms have a stake in their traders following the rules and managing risk as the firm’s capital is at risk. This oversight can include regular performance reviews, risk audits and strict adherence to the firm’s trading policies.
While this structure may limit a prop trader’s freedom, it can also provide a framework for disciplined trading and help reduce losses. Retail traders have more control over their trading decisions but still have to comply with margin requirements, position limits and other regulations from their broker and regulatory bodies like the SEC or FINRA.
Retail traders are ultimately responsible for their own risk and compliance with the laws and regulations.
Profit Sharing
Prop traders are usually compensated with a percentage of their trading profits which can be as high as 50-70%. This aligns the trader and the firm’s interests, to manage risk prudently. Retail traders keep all their profits but also bear the full brunt of their losses.
The profit sharing model in prop trading can be a big motivator for traders to perform well and grow their accounts as their compensation is directly tied to their trading results. This also means prop traders can focus on long term profitability over short term gains as consistent performance is rewarded more than one off high risk trades.
However profit sharing also means prop traders may have to meet performance targets and have a portion of their profits withheld by the firm for operational costs and risk management purposes.
Retail traders have full control over their profits but also have to manage their own risk and ensure the longevity of their trading capital. Retail traders can reinvest their profits to grow their accounts or withdraw funds as needed. But they also have to be prepared to take losses and have sufficient capital to trade.
Conclusion
Prop trading and retail trading both have their reasons to exist. In both you need to have good skills in market analysis, sentiment analysis and risk management. Those who want to read and understand the terms and conditions of prop trading challenges and account funding in a prop firm consider prop trading as a lower risk entry with higher reward. Traders who prefer making their own rules and performing at their own pace may consider retail trading with traditional brokerage houses.
