Introduction
Trading has never been so accessible. Modern-day traders are extremely fortunate to have access to the financial markets via online brokers with tight spreads, low commissions, and almost instant trade execution. There is a seemingly endless amount of educational content on the internet and a plethora of high-quality software available for charting and testing strategies.
The only limitation to earning a large amount of money from the financial markets now is capitalization. Have online prop firms solved this problem?
Let’s take a look!
Understanding Prop Trading Accounts
A prop firm trading account is essentially capital provided by a prop firm to a trader to execute trades on the firm’s behalf. In return, the firm shares the profits with the trader based on a pre-agreed percentage. Typically, to gain access to an online prop firm trading account, a trader will be required to pay a fee and pass a trading evaluation while adhering to a set of rules. Once the trader has qualified for a funded prop trading account, they are given access to either simulated or real funds that they can trade in the financial markets.
Are Online Prop Firms a Scam?
Capital provided by most online prop firms is “simulated,” leaving the prop firm with the decision of whether to copy trades to the live market or take the other side of the trade(s) themselves. This leads many traders to believe that prop firms are a scam because their interests cannot be aligned with the trader’s if the firm is taking the other side of their trades.
How a firm decides to manage its trading volume is up to them. Offering simulated capital doesn’t in itself make a prop firm a scam. A prop firm is only a scam if they fail to abide by the terms of their contract with the trader. If the trader follows the prop firm’s rules and makes a profit, the firm should pay the trader their profit split without any question. As long as they do this, they are not a scam.
We advise traders looking for a prop firm to stick with well-established firms that have built a solid reputation for paying traders. Firms such as FTMO, The5ers, and FundedNext are great examples of firms with a long history of paying their traders.
The Harsh Reality of Undercapitalization
Once they’ve overcome the challenges of creating a profitable trading approach, the biggest hurdle facing new traders is capitalization.
In trading, it is not realistic to make huge percentage returns every year. The reality for most profitable traders is that they will average a return of somewhere between one and five percent profit each month. This means that to average $1,000 profit per month, a trader will need between $20,000 and $100,000 of capital that they can afford to put at risk trading the markets.
It’s quite safe to assume that the vast majority of new traders do not have access to this amount of capital. Furthermore, most new traders will have ambitions far exceeding $1,000 profit per month.
Historically, new traders would have to start trading with whatever amount they could afford to lose, then very gradually grow that account over time. This process could take many years before the trader is earning enough profits from their trading account to regularly withdraw money that would make a difference in their lives.
Maximizing Return on Investment with Online Prop Firms
Online prop firms allow traders to access significant buying power for a relatively small amount of personal risk. The only personal risk to a trader who chooses to trade with an online prop firm is the possibility of losing the evaluation fee. For example, a trader could pay for a $5K High Stakes evaluation with The5ers, and their only risk would be $39.
If the trader in this example passes their evaluation, they will be given access to $5,000 to trade the financial markets. Let’s assume that the trader takes a conservative risk management approach of risking 0.5% ($25) per trade and is able to average a return of 5R per month. The trader will stand to earn $125 ($100 after profit split) per month from their initial $39 risk. If the same trader had put that $39 into a personal trading account, with the same risk percentage per trade, they would earn around $0.98 per month.
We can apply the same logic to a bigger account. Typically, a $100K prop firm account costs around $500. If a trader risks 0.5% of a $100K account and averages 5R per month, then they will earn $2,500 ($2,000 after profit split) per month on average from an initial $500 risk. If they were to put that $500 into a personal account with the same risk management strategy, they would earn $12.50 per month.
Online prop firm accounts typically scale up and/or increase profit split percentages over time, giving the trader even more buying power and earning potential without taking on any additional personal financial risk.
Online Prop Firm Effect on Trader Psychology
Trading is psychologically tough, but trading with an online prop firm brings the security of knowing that you can only lose the evaluation fee. Trading $100K with a prop firm is significantly less risky than trading with $100K of personal capital.
Traders can be emotionally attached to their money, which can lead to poor decision-making as fear and greed set in. Trading with an online prop firm removes a large part of this pressure because the trader cannot lose significant personal capital no matter what happens. Their maximum personal exposure is only ever going to be the evaluation fee.
Without the risk of losing significant personal capital, the trader is free to make more objective and calculated trading decisions, which can lead to much better performance and thus much higher financial gains.
Online Prop Firm Effect on Risk Management and Discipline
Trading with a prop firm has a profound impact on a trader’s risk management and discipline, which are two critical components for long-term success in the markets. Prop firms enforce structured risk management rules that help traders stay within defined parameters, preventing excessive risk-taking and fostering greater discipline.
One of the major advantages of trading with a prop firm is that it comes with stringent risk management protocols. These firms often impose daily and overall drawdown limits, which act as safety nets, preventing traders from losing more than a predetermined percentage of their account. This external risk management structure forces traders to develop and stick to disciplined strategies, which can be harder to enforce when trading with personal capital.
For example, a prop firm might limit a trader’s maximum loss to 5% of their account balance or restrict the amount of capital that can be risked on a single trade. These guidelines ensure that traders don’t blow up their accounts due to emotional decision-making or an unexpected market move. This is especially beneficial for newer traders, who might still be learning the importance of consistent risk control.
Conclusion
While trading with personal capital offers independence and full control over trading strategies, prop trading accounts provide significant advantages that are hard to ignore. Access to larger capital, limited personal risk, professional risk management, and the potential for greater profits make prop trading a compelling choice for traders who are confident in their abilities but may not have the financial resources to back their strategies independently.
Prop firms also alleviate some of the psychological and financial stress associated with trading, which can lead to better decision-making and more consistent profits. For those willing to adhere to a firm’s rules and share in the profits, the value of prop trading accounts can far exceed that of personal capital accounts.
It’s entirely feasible for a profitable trader to start out with the smallest prop account available, and thus a very small amount of personal risk, and use profits from that and future accounts to build up their funding to well beyond seven figures. That potential return on investment is quite remarkable, and we are lucky to be in this industry at a time when such opportunities exist!
Ultimately, the choice between trading a personal account and using a prop firm depends on the individual trader’s goals, risk tolerance, and financial situation. However, for many traders, prop trading can be the bridge between a small account and a sustainable, profitable trading career.