prop firms

Discussion in 'Professional Trading' started by ptunic, Mar 8, 2004.

  1. ptunic


    [ I've created this new discussion thread since this isn't really for the hedge fund discussion ]


    I'm open to anything that makes sense. But for one thing I don't understand how prop firms work. And from the little bit that I have read, it doesn't sound like a good fit in my case though I am sure it makes perfect sense for other cases.

    Some questions / concerns I would have this this route:

    - How do prop firms make money? Is it through sharing commissions on trades? Is it through borrowing against the assets of the traders? (ie if I put $50K down then you can borrow 1 million or so and do interest rate swaps or your own investing)? Is it the prop firms have their own seperate large investors or internal capital and they mirror-trade the best performing prop traders? Also I read something about overnight interest charges.

    - It seems a lot of the math involved with prop firms involves leverage. Just how much are we talking about and how is that leverage used (both from a prop traders standpoint and the company's standpoint). Ie if I use my own $50K, and you give me $1 million to trade with, first of all am I paying interst on this? If so then I might as well 2nd mortgage my own house for capital. If I lose $1 million do I have to pay back the million or am I limited to a $50K loss.

    If I put in $50k and the company gives me $2 million to play with, does the company also invest say $10 million mirror-trading my investments. That would hurt me as far as price impact if the numbers got big enough. (Granted this problem occurs in hedge funds too-- if you have $50 million AUM in certain cases you can impact prices).

    - Back to overnight interest, and trading style in general, unfortunetly my system is not a day trading system. My positions are *always* open overnight, and almost always for an average of about 2 weeks. I think I read something about a high charge for having overnight positions. Thus it was my guess that prop firms are mostly useful for experienced day traders as opposed to those who follow longer term strategies.

    - I'm not sure I want other people knowing exactly what my positions are since there is a chance they can reverse engineer the system (well I have a few tricks to make that hard but still) :)

    I know that sounds paranoid but intellectual property is a form of property after all and you wouldn't leave a couple gold bars just lying in your driveway, would you? Again I know this problem applies to hedge funds as well to some degree as you need auditors, but when done correctly you can minimize this risk, perhaps even using 4 brokerage firms / accounts and have 4 different auditors then a master auditor to add them all up. I know that is complex and costly but it is probably better than having vultures arb against your own strategy and suck the returns out of it :)

    - My strategy makes use of options on US stocks for various reasons instead of the underlying stocks. I thought most prop firms only let you trade in actual stocks. In addition, once assets are large enough I want to add future options (currencies + commodities).

    So as you can see for all these reasons I don't know if the fit is the best for a prop firm. Perhaps if I try fund-raising for 2 years without any results then with some adjustments this might be the way to go, as it probably would be better than letting my own money take its time to grow since I'm starting with such a small base.

  2. Well, you have some "interesting" comments. First off, we don't "pool" the traders money to loan out (I know that many firms do, we happen to be in the minority, we actually have plenty of capital without the traders you probably know, we return capital immediately, etc.).

    As far as "mirroring" your investments...I have to smile...I know you're serious, but since we keep a hundred million "family" portfolio ourselves, I don't think we would have the time or desire to bother with someone elses...

    And, as far as keeping overnight positions, and using our capital, it simply makes sense to pay interest vs. paying out 80% or so of your profits to outsiders.

    Our fees are much lower than most hedge funds pay...

    You would have to prove your trading skills, and have additional capital usage stem from your success....and the idea of using options (especially in this day and age, with current volatilities) is a bit maybe, in your case, you (as an individual), may be better off risking OPM....but if you have the sincere belief that you can actually make "net" money, why give the profits away?

    In any case, there are many ways to make money in this business, and I hope that you succeed, regardless of the structure you end up with.

    All the best...

  3. ptunic



    Ok-- thanks for the replies. Yeah some of my ideas might have been off the mark since I don't understand how it works that well.

    I still didn't understand how the firm makes money, besides commissions and overnight charges. Or is that it? If you give me $1 million (eventually) to trade with I assume I have to pay interest on it? If so is that usually where the firm makes profit? (Assuming it makes more it the interest spread than defaults).

    Let's say I invest $50k, you give me initially another $100k to trade with. So I have $150k. Let's say I make a 10% return the first year after commissions. Does that mean I would have $50 + $15k = $65k at the end of the year (minus taxes)? This is assuming no overnight charges for now. Or do I also have to pay interest?

    Or let's say I lose all $150k. Do I owe you $100 back now in addition to losing my own $50k.

    Also, am I allowed to use my own strategy by itself (assuming I use stocks not options and use approved markets: NYSE + NASDAQ for example)? Or am I forced to incorporate elements of the prop firms' strategy such as proprietary entry or exit signals and money management, etc?

    Also are there any minimum trading guidelines? Ie if I only place 20 trades a month is that too few?

    Basically I'm trying to figure out "what's the catch" :) Ie is there any downside-- at least over just trading my own money.

  4. We make our money through "economies of scale" (commissions, yes, based on billions of shares traded annually). We don't have to "borrow" money, we actually need to put it to good use, and this is how we choose to do it. You can trade any way you like (within basic risk parameters). You can trade as much or as little as you like...the "sliding scale" pricing helps you as you trade more.

    We cater to independent traders, not the "employee types"...we want those who can actually make money trading, not those looking for a hand out. The "hedge fund" business model is just a very inefficient way for traders to get started. Good traders like to trade for profits, poor traders want to start a hedge fund so they can keep the 2 or 3 percent of "free money" ...(I know that sounds a bit rough, and there are few exceptions, but very few).

  5. As someone who left that used to be elite prop firm to run my own daytrading desk within a larger market making firm - i can assure you that the way prop firms make money is commissions - plain and simple.

    it isn't any more complicated than that.

    Maybe Schonfeld/retail would be a good place for you. Check it out.