A prop shop is a proprietary trading firm that uses its own money to buy and sell financial instruments such as stocks, futures, options, currencies and bonds. It earns money from trading results rather than commissions paid by brokerage customers. This article was last updated on ****. The firm may trade seven core market categories, plus related derivatives.
Prop Shop at a Glance
| Feature | Typical prop shop |
|---|---|
| Capital | The firm's own money |
| Main activity | Trading financial markets |
| Customers | Usually no external trading customers |
| Traders | Employees, contractors, partners or owners |
| Strategies | Market making, arbitrage, algorithmic trading, spread trading and directional trading |
| Revenue | Trading profits |
| Main risk | The firm can lose its own capital |
How Does a Prop Shop Work?
A prop shop gives traders access to the firm's capital, trading technology, market data and risk-management systems.
Traders use those resources to place trades. When the trades make money, the firm and trader usually share the profits under an agreed compensation structure. When trades lose money, the firm absorbs the loss, subject to internal limits and risk controls.
Prop shops may trade:
- Equities
- Futures
- Options
- Foreign exchange
- Fixed-income securities
- Commodities
- Cryptocurrency
- Related derivatives
Some firms focus on one strategy. Others run several trading teams, with each team responsible for a different market or approach.
How Does a Prop Shop Make Money?
A prop shop makes money when its trading profits exceed its trading costs and losses.
Common strategies include:
- Market making: Quoting buy and sell prices and earning the difference between them.
- Arbitrage: Exploiting price differences between related markets or instruments.
- Statistical trading: Using mathematical models to identify short-term pricing patterns.
- High-frequency trading: Using automated systems to place a large number of rapid trades.
- Spread trading: Trading the price relationship between two related contracts or assets.
- Directional trading: Taking a position based on the view that an asset's price will rise or fall.
The National Futures Association describes proprietary trading firms as businesses that may use arbitrage, directional speculation, high-frequency trading, algorithmic trading or spread trading.
Why Do Traders Join a Prop Shop?
Traders join prop shops for access to capital, market data, technology and trading systems that may be expensive to build independently.
A prop shop may provide:
- More trading capital
- Professional trading platforms
- Direct market access
- Real-time market data
- Research and analytics
- Automated trading infrastructure
- Risk-management tools
- Training and mentoring
- A structured trading environment
Firm capital can also give traders more buying power than they would have in a personal account. That increases the size of both potential gains and potential losses.
Prop Shop vs. Hedge Fund
A prop shop trades the firm's own capital. A hedge fund trades money contributed by outside investors.
| Difference | Prop shop | Hedge fund |
|---|---|---|
| Source of capital | Firm's capital | Investor capital |
| Main relationship | Traders and owners | Fund managers and investors |
| External investors | Usually no | Yes |
| Typical income | Trading profits | Performance fees and management fees |
| Investor redemptions | Not usually relevant | Important operational issue |
| Customer assets | Usually not held | Fund assets are held for investors |
A hedge fund may use many of the same strategies as a prop shop. The key difference is the source of the money and the legal structure around it.
Prop Shop vs. Brokerage
A brokerage executes trades for customers. A prop shop trades for itself.
A brokerage may earn commissions, spreads, lending income or other customer-related fees. A traditional proprietary trading firm earns money from the results of its own positions.
Regulatory definitions often focus on whether a firm trades its own capital through its own accounts and whether it has customers. FINRA materials describe proprietary trading firms as firms that trade exclusively for their own accounts and do not conduct customer business.
Prop Shop vs. Online Funded Trader Firm
The phrase prop firm is also used by online trading businesses that sell evaluation programs to retail traders. These programs may require a trader to pay an evaluation or subscription fee, meet profit targets and follow daily-loss or maximum-drawdown rules.
That model may differ from a traditional prop shop.
A traditional prop shop generally:
- Employs or contracts traders
- Allocates firm capital
- Uses professional trading infrastructure
- Makes money mainly from trading performance
An online funded trader program may instead involve:
- A paid trading challenge
- Simulated or demo trading
- Strict account rules
- Profit-sharing terms
- Reset or subscription fees
The CFTC has warned that simulated results do not represent actual trading and may not reflect liquidity, execution or other real-market conditions.
Before joining an online prop firm, check:
- Whether trades are executed in live markets
- How losses are calculated
- Which fees apply
- When withdrawals can be made
- How profit-sharing terms work
What Is a Physical Prop Shop?
A physical prop shop originally referred to a proprietary trading group whose traders worked electronically from a shared facility. The CFTC glossary still defines a prop shop in those terms, although many modern firms allow traders and developers to work remotely.
Bottom Line
The phrase prop firm can describe two different models. A traditional prop shop hires or contracts traders to trade firm capital. An online funded trader business may charge for evaluations and use simulated accounts.
Before working with one, identify where the money comes from, whether trades are live and how losses, fees and withdrawals are handled.