The Opportunity for a Prop Trader

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@DynamicHedge wrote a must-read piece recently that went viral, “Letters to a Young Trader”, in which along with buckets of awesome advice he also asserted prop trading shops are dying.  This is true.  But this is not the same as prop trading is dead and/or ALL prop shops are dying.  That would not be correct.  The author never stated this but some might have missed this important distinction.  This is an opportunistic time for the right people to be prop trading!  Let me explain why and offer a status update on prop trading.

First here is what @DynamicHedge wrote about prop trading:

(Question from @dynamichedge reader)It doesn’t seem like many proprietary trading firms are hiring these days and large financial firms are basically on lock down since 2008.  I received an offer from a firm called [insert firm name] but turned it down.  I got a bad gut feeling about it and they wanted me to pay them initially, then get firm capital.

(@dynamichedge response) Prop shops are dying.  Only one in a hundred are worth your time and they’re not hiring because the business model is dead.  It’s the end of an era.  The truth is that prop trading hasn’t been that great since the the days of decimalization.

Keep in mind that not every place that requires you to put up capital is a scam but they do deserve extra scrutiny and due diligence.  The previous notes on seed capital apply. (end of @DynamicHedge response)

Over the past three years prop shops have closed and downsized.  This is true of even the best prop shops.  Risk on discretionary traders has been decreased or eliminated.  Trading profits by many discretionary prop firms has declined.  Most Arcades, an entity where you put up first loss capital to trade, offer a new or experienced trader little chance of success and harm the reputation of the industry as a whole.   2009-2011 were down years for prop trading, which can be a cyclical business, leaving hoards of failed prop traders, yet bright individuals, quick to bash the industry instead of seeing their experience for what it was potentially.  A sub-optimal time to start.  Or perhaps trading was just not their thing (The Failure Rate of a Proprietary Trader).  New regulation on most prop traders makes it more expensive for trader and firm.  This leaves even some of the better firms to wonder if their ROI makes it all worth it.

Some well-known prop firms have lost confidence in the business model of the discretionary prop trader.  They are enamored with automated trading strategies even if this is not their core competency.  Some of the better prop shops are seeing an increase in profits from automated trading and are mostly interested in quant growth.   Traders can be hard to deal with while a good system just prints money and is more scalable than the median prop trader.

Having said all of that from my seat I see a huge opportunity going forward for the right prop traders.  This begs the obvious follow ups: Why? And who are the right prop traders?

If you are sitting at a job that you cannot stand (unfortunately a large percentage of our population) and dream of a better life with no passion for trading, then prop trading is not your answer.  If you have just graduated from college and want to give prop trading a shot with no passion for trading, you will soon be a former prop trader.  Unfortunately the low barrier of entry to some prop firms and aggressive recruiting tactics by lesser arcades lures some into this career misstep.  More unfortunately, the rest of us can get mistaken for the lesser arcades since it appears from the outside we do the same thing.  Hah!  Every prop firm is different from their dress code to their payout to their core principles.  Think of a college basketball squad.  Does every college basketball player have the same experience as matriculating at Duke and being coached by Coach K?

The right traders are those with a passion for trading, who will work on their trading game daily, with the mindset of improving each day.  Moreover, new prop traders should start building skill even before they turn prop (So you say you want to be a pro trader).  Process, process and more process should be their mantra.  Do the right thing.  Make one good trade (I hear good things about a book with the same title).  Step outside of your comfort zone each day.  Practice your trading after the close like an elite athlete does.  There is never a place to get to, there is no top of the mountain, there is just the endless, enjoyable journey of daily improvement for the sustaining, professional trader.

So let’s say we think we have found ten of the right traders through advanced recruitment screening.  This only after combing through thousands of resumes and doing hundreds of interviews.  What will be the success rate of these traders?  This is the data that I have:

  • 5 will fail because they do not have a passion for trading, even though trader and firm thought they did
  • 3 will be terrific (The Big Three)
  • 2 will be on the cut line

Of those on the cut line, 1 will just not get it and fail.  And the other will be a flip of the coin for success depending on the market, their choice of firm, their fit with the trading product they chose, and other variables too numerous to list.

So what can those Big Three expect?  At the end of Year 1 they should aim to hit a run rate of 100k in gross P&L.  At the end of Year 2 they should strive to reach a run rate of 250k in gross P&L.  Note these goals are assuming a firm business model with responsible risk control, never being in a position to place the whole firm in jeopardy from trading losses.  On its face these profit goals do not seem all that enticing.  But its in Year 3 where it is worth it for the right trader.  And it is with a changing trader landscape that makes prop trading really appealing.

How?  Year 3 is where we see traders make the most progress.  This is where they realize outsized trading gains and move to a status of making real money.   Making some pocket change for two years doing what you love becomes worth it with the potential reward to the superior discretionary trader in Year 3.

But it gets better.  It used to be that a prop trader was limited to one trading product at most shops.  So you started as an intraday equities trader and progressed to an intraday equities trader, who traded with more capital.  This was the most we could offer.  Today we can do better because of technology and education.  A prop trader is not limited to just trading one product.   They can intraday equities trade and learn Options.  And Futures.  And FX.

And it gets better.  It has become easier for prop traders to develop automatic trading systems based on the trading expertise they developed as a discretionary trader.  You do not need to learn to code to build these systems nor work at a quant house.  So your discretionary trader gross P$L number can be supplemented by automated systems that you develop, backed by your firm.

Why not just skip the first two years of discretionary trading and start immediately with building automated trading systems?  Some do.  And this is the business model of some trading firms.  I wonder if this is the best way to start for most.  Since the markets are dominated by automated strategies that go in an out of favor isn’t it best first to learn how to trade?  Developing the skill of a discretionary trader will help you quickly spot the patterns that are being rewarded by each new market.  Most automated strategies rely on past results.  When the market structure has clearly changed many back-tested trading strategies will no longer be effective.    It will take the trading eye of the advanced discretionary trader to understand the patterns that will get you paid in the changed market.  And thus the automated strategies to run.

And its gets even better with an idea that is too ripe for many to value.  Soon more will have access to most world markets.  Today almost all of the intraday US equities traders cannot trade SGX or JALSH or even the DAX.  This will in time open up for the discretionary prop trader.  Instead of trading the US equities markets 6 hours after good news from the Eurozone, they will be able to trade European banks and their markets in real-time.  This will open up a new world of trading opportunity for the skilled discretionary trader.

Five years into your trading career you can be a multi-product, multi-market discretionary trader, with a series of automated strategies running.  This all takes a great deal of work, excellent training, passion, a value-add firm environment, outstanding trading technology, realistic expectations about profitability and some monetary backing.  But this is the future career path for the prop trader.  For the right traders this is a great time to be a prop trader.


One Good Trade

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