Principal vs Proprietary trading guide

Principal and proprietary (prop) trading are two very different trading activities. Principal trading, also referred to as agency trading, is the practice where a financial institution acts as an intermediary between securities buyers and sellers. The broker/financial institution facilitates trades on behalf of its clients. It’s important to note that the financial institution doesn’t take a direct position in the securities that are being traded, and therefore there’s no conflict of interest.

Principal trading is mainly client focused. The financial institutions facilitating the traders have major responsibility to execute trades with accordance to the interests of their clients.

Proprietary trading, also known as prop trading, involves financial institutions such as prop trading firms, and hedge funds, trading their own money with the main goal to maximize their profits and minimize risks. The key difference between principal trading and prop trading is that principal trading is client-focused, whereas prop trading is aiming to increase income for financial institutions.

How to prop trade

Prop trading firms are on constant hunt for talented traders. Traders that receive funding from prop trading firms participate in financial markets, and profits generated from trading are split based on predetermined and agreed upon profit sharing ratios.

In order to find the best traders, prop firms typically have 2 or 3-step evaluation trading challenges. Traders generally are required to pay one-time challenge participation fees to prop firms. Fees vary depending on account funding plan and from prop firm to prop firm.

Before participating in a prop trading challenge, it’s important to make a list of your preferences. Some firms set strict limitations on asset classes traders can access, and available leverage. Every prop firm is different and has different offerings to their clients, but in general, they all share certain characteristics.

In general, traders have profit targets, daily loss limits, maximum account drawdown limits, and certain time frames they need to meet. As already mentioned, prop firms are aiming to maximize their returns and minimize risks, which is why the maximum typical offered leverage is ranging between 20:1 to 50:1.

In order to start online prop trading, you need to find a proper prop firm, have strict risk management rules in place, and have a profitable trading strategy. Winning a trading challenge is not easy, and traders need to be focused during these events.

In addition to online prop firms, there are prop firms that offer office space, education, and essential tools for profitable trading.

Closing Thoughts

To sum it all up, principal trading involves a financial institution acting as an intermediary in securities transactions, facilitating trades for clients without taking a direct position in the trade. This client-focus approach ensures zero conflict of interest. Prop trading entails trading with the prop firm’s own money to maximize profits and minimize risks. Earnings made by traders are divided between prop firms and their traders with agreed upon ratios. To get funded by a prop firm, traders need to successfully complete trading challenges. It’s important to look for regulated companies or make sure that your prop firms are working with regulated brokers to ensure safety.

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