Why so many prop firms are collapsing?

Why so many prop firms are collapsing?

Written by

Craig Ogley

Written on

Jul, 2024

Updated on

Jul, 2024

Table of content

The proprietary trading industry is a fast-growing financial sector that aims to democratize access to trading capital. With many prop firms offering funded accounts with large trading capital, the competition for market share is fierce. Recently, a new tendency has started where many young prop firms fail to meet their promise and collapse due to various factors. Let’s now analyze what are the main causes for these mass spread failures and how prop firms can counter these threats.

Prop trading explained

Proprietary trading or prop trading is when traders can access a prop firm’s capital in the form of funded accounts and trade on financial markets with the firm’s money. This unique arrangement allows traders to not only access a large trading capital which would be difficult otherwise but also trade risk-free. Prop firms typically charge small fees to allow traders to purchase funded account challenges, where traders have to operate under predetermined risk parameters and achieve a certain profit target. Traders can pass this funded challenge and then start trading on a real funded account. Prop firms have risk limits and rules to protect their capital from irresponsible trading and market risks. Here are some of the most popular rules and limits:

  • Daily risk limit — Traders are prohibited from losing more than an uncertain percentage of their account on any given trading day (usually varies between 4-5%)
  • Maximum drawdown — Traders are prohibited from losing more than a certain amount overall (usually varies between 6-8%)
  • Profit target — All prop firms have a profit target, which traders need to achieve to get funded (usually between 6-10%)
  • Other rules — Some firms prohibit news trading, and holding open positions overnight and over the weekends

Why are prop firms so popular lately?

This unique opportunity has driven the popularity of prop firms and more and more firms are launched almost daily basis. Prop firms offer funded accounts which often range from 5,000 USD and 200,000 USD. Besides these default options, there are often also scaling plans offered that allow traders to increase funded account size even further. By paying tiny fees, traders at all budgets can access substantially larger amounts of trading capital than what they could normally afford. This unique possibility of accessing large accounts for very tiny fees makes prop trading a widely popular and fast-growing financial sector.

Benefits of applying for funded accounts

The definite benefits of prop trading on funded accounts include:

  • Access to a large trading capital
  • Almost risk-free trading
  • Access to cutting-edge technology
  • Education and support

The reasons for the failure of prop firms

The recent collapse of so many prop firms can be attributed to several critical factors.

Regulatory crackdowns

The recent tendency of the USA regulatory crackdowns on prop firms has reflected in many firms being forced out of business. This is a primary drive behind all the turmoil in the prop trading industry. Prop firms, especially those accepting US-based traders, have faced significant issues due to regulatory and compliance issues. The U.S. Commodity Futures Trading Commission (CFTC) has taken legal actions against some firms for alleged fraudulent activities, completely changing the landscape in the country.

MetaQuotes licensing issues

There is a rumor that MetaQuotes, the company behind popular advanced trading platforms MetaTrader 4 and MetaTrader 5, is joining the CFTC in the crackdown on prop firms. All prop firms accepting USA-based clients will have to get regulated by FINRA or NFA to get access to MT5, even if the firm is offering educational services only.

Financial challenges

There are also minor challenges in the industry. The business model of prop firms is to sell trading challenges and fund successful traders, which is highly susceptible to market volatility and financial instability. The competition is very fierce, and price wars make it difficult for new prop firms to solidify their positions and ensure long-term presence in the market.

Brokerage service terminations

EightCap, a popular regulated broker with prop firms, has responded to these regulatory crackdowns by terminating its services to several prop trading firms. This is direct damage to these prop firms and another main drive, forcing prop firms out of business.

How to stay in the industry for the long term — Pro Tips

The most important tip for prop firms is to ensure their compliance with regulations in the jurisdictions they are going to operate. They need to stay updated about upcoming rules and regulations and seek legal counsel from professionals. Another important tip is to diversify technology and platform use. Searching for alternative trading platforms to offer in parallel to MT4 and MT5 is also crucial to stay in the business if MetaQuotes terminates your platform license. To counter financial risks, prop firms need to strengthen financial management and have a strong marketing team to develop competitive products and effective marketing campaigns.

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