Table of content
Prop trading is different from traditional financial trading. While the basic principles of both financial trading strategies are similar, the goal and focus are different. Prop trading refers to trading financial markets using funded accounts provided by proprietary firms, which allow traders to pass an evaluation challenge and start trading on FX and other markets using the firm’s capital. Traders typically pay small fees for participating in these challenges and after proving their skills are given large trading accounts often in hundreds of thousands of dollars. Prop trading because of this unique model is a very attractive endeavor, but depending on the trader’s skills and experience there are several factors to consider. There are strict risk control rules and trading restrictions when opting for prop trading challenges and traders need to understand these rules and develop suited strategies to succeed. So, let’s start outlining the best practices to pass evaluations and start trading with funded accounts.
Forex prop trading explained
Proprietary trading is when the firm makes profits by speculating financial markets rather than providing trading services like Forex brokers. Unlike Forex brokers, prop trading firms are incentivized to select only profitable traders to trust their large funded accounts and ensure long-term relationships. Some prop firms employ traders by selecting and teaching them and paying salaries and bonuses, while others provide challenges and give funded accounts to whoever will pass the challenge. We are going to focus on the latter.
Prop firms have strict risk management rules and prohibit certain trading methods to protect their capital. Here are the main rules of prop firms:
- Daily loss limit — the maximum percentage of funded accounts that can be lost on any single day
- Maximum drawdown — traders are prohibited to lose more than this percentage overall
- Stop-loss requirements — the majority of prop firms enforce traders to always use stop-loss orders ensuring their capital is protected from sudden substantial losses
- Restrictions on specific trading hours — many prop firms prohibit trading during major news releases, holding positions overnight or over the weekends
- Restrictions on specific trading strategies — hedging, trade copiers, automated trading strategies, and arbitrage are typically prohibited
As we can see, prop traders have to follow strict rules, making many trading strategies unusable in the process. So, if you are planning to use a strategy that is profitable but is expected to lose more than 5% on some days you might need to reconsider it.
Despite these obvious hurdles, there are steps traders can take to develop well-adjusted trading methods that can withstand the complex requirements of prop firms and still produce profitable results while operating within the set risk parameters of the prop firm.
Setting Up for Success
When deciding to participate in a prop trading challenge, there are several critical steps to go through.
Importance of a trading strategy
Trading without a trading strategy is a bad idea even in general FX trading and in prop trading, traders need to develop specific approaches to be profitable and not lose more than the firm allows. A trading strategy is a list of rules and steps for opening and closing trading positions and managing risks and rewards. This is critical in prop trading, as prop firms won’t allow a trader to lose more than 5% of their capital on any given trading day.
Psychological readiness and managing emotions
When undertaking prop firm evaluation, traders typically need first to pass the challenge phase by hitting certain profit targets without breaching any of the rules including risk management, trading methods, and trading times. This puts enormous emotional pressure on a trader and is often enough to cause stress and bad trading decisions. This is why executing a trading strategy with emotional balance and discipline becomes so critical. It is frustrating to trade days on a demo account and only switch to a funded account.
Tools and resources for effective prop trading
To monitor trader’s progress and their compliance with set trading rules, traders need to employ statistical tools. These tools are provided by reliable prop firms in the shape of trader’s dashboards where traders can track important stats and monitor their progress.
Risk Management Essentials
When it comes to prop trading, trading without strong risk management rules will lead to disqualification. Risk management is probably the number one priority which needs to be followed all the time and in all prop trading strategies without errors. The most essential risk rule is to maintain the daily loss levels below 4-5% which can be only achieved by exercising strict risk management strategies. Traders need to consider strict stop-loss and position-sizing methods to avoid getting disqualified when passing the valuation stage. Try not to risk more than 1% on each single trade if your strategy allows you to open 4–5 trades, and lower risk per trade even below 1% if your trading method includes opening more than 5 trades per day. Since many prop firms restrict from holding open positions overnight, traders often have to opt for more short-term trading methods, and maintaining strict risk control becomes even more critical. Risk management also depends on the trading strategy and method. For trend followers, it is critical not to risk more than 1% on any given trade, as these strategies are known for their low win rate ratio. If you are expected to lose several trades in a row, it is much easier to hit the daily risk limit and end up breaching the rule. Here are some useful tips for maintaining proper risk control when trading an evaluation account:
- Ensure not to risk more than 1-2% on any trade and if your win rate is below 50% reduce the risk even further
- You can control how much you risk on each trade by using position sizing, reducing position lot size when the stop loss is larger, and increasing it when the stop loss is small
- Depending on the win rate of your strategy, ensure you can withstand the corresponding number of losing trades in a row
- Include risk management into your trading plan to always use it in your prop trading
- Always use a stop loss orders to limit potential losses
To ensure you understand the impact of the probability of losing streaks on your account here is a table:
Trading strategy win rate (winners/100 trades) versus the probability of a losing streak for 1,2,3,4 consecutive losing trade
| 50/100 | 66/100 | 80/100 | |
|---|---|---|---|
| 1 | 1/2 | 1/3 | 1/5 |
| 2 | 1/4 | 1/9 | 1/25 |
| 3 | 1/8 | 1/27 | 1/125 |
| 4 | 1/16 | 1/81 | 1/625 |
Write down this table as it can save your prop trading career. It is critical to know how many losing trades in a row is your trading strategy expected to have. For a 50% win rate trading strategy which is expected to win 50 trades out of 100, the probability of losing 2 trades in a row is 1 out of 4. Once in every 8 trades, a trading strategy with a 50% win rate is expected to lose 3 times in a row. Without strict risk per trade, the trader is guaranteed to breach the daily risk limit rule and get disqualified.
Let’s now continue to trade strategies that are popular among traders and define which ones are most suitable for successful prop trading.
Strategies for Forex Prop Trading
Many trading strategies can be implemented for profits, but only a few stand a chance in prop trading. Let’s examine popular methods and assess which ones are most useful in proprietary trading.
Trend Following Strategies
Trend following is probably one of the oldest and most profitable trading methods. However, catching trends is not an easy task and these strategies are known for their low win rates of below 50% (often 36-40%). You can use trend-following methods to make huge profits in general FX trading but employing them in prop trading profitably can be very tricky. The low win rate greatly increases the probability of losing 4–5 trades in a row, which is a receipt for a disaster in prop trading. It is difficult emotionally to experience consecutive losses and still follow your trading strategy flawlessly. It is also very easy to hit the maximum daily risk limit when losing a few trades in a row is highly expected. If you ever try to use trend-following strategies in prop trading, ensure to risk more than 0.5% on each trading position to meet the risk requirements.
Range Trading Strategies
Trading the range usually involves swing trading strategies, where traders try to buy on the lower end and sell on the top of an already established price channel. While range trading strategies can provide above 50% win rate with 1:2 risk-reward, traders still need to be aware of our probability table above. In this scenario, the win rate is higher and traders can theoretically afford to risk around 1% on each trading position, although we would suggest risking similarly to trend-following strategies.
Scalping for Quick Gains
Scalping strategies are known for their higher win rates and correspondingly higher possible position sizing. However, this increased win rate comes at a cost of risk-reward ratio, and the majority of scalping strategies are expected to win about the same amount or lower they risked per trade. Some scalping strategies might have a higher than 66% win rate and when hitting around 80% win rate the losing streaks tend to almost disappear. This opens a possibility to trade with more than 1-2% per trade and quickly complete the evaluation. So, scalping strategies with more than a 70% win rate are strong contenders to work perfectly with strict risk rules set by the majority of prop trading firms. One reason why scalping strategies have higher win rates is their low risk-reward ratios. It is much easier to hit small profits than aiming for larger price movements.
Avoid these strategies in prop trading
Position Trading for Long-Term Success
Position trading for long-term success involves holding trades for weeks or months to capitalize on significant market movements. This strategy will need adjustments to be useable in prop trading, as the majority of props won’t allow overnight and over-the-weekend trading activities. If you find such a prop firm, it is essential to reduce the time you are planning on holding trading positions for this strategy to be profitable in prop trading. Despite the drawbacks, position trading can be very effective as it is relatively easy to catch medium-term price movements.
Carry Trade Strategies
Carry trade strategies involve borrowing or selling financial instruments with low-interest rates and using the funds to invest in instruments with a higher interest rate. As we can see, without heavy adjustments, this strategy won’t be useful in prop trading as it involves practices that are more effective when executed through several platforms.
Common Pitfalls to Avoid in Prop Trading
When signing up for the prop trading challenge, there are several common mistakes to avoid. Let’s list these pitfalls to enable traders to pass evaluation phases more easily:
- Ignoring the trading plan – deviating from the trading strategy will guarantee you breach prop trading rules
- Overleveraging – When trading on a large demo account of evaluation, misusing leverage can lead to substantial losses and disqualification from the evaluation
- Not following risk management very strictly – deviations from risk management rules guarantee trader breaches risk limits
- Lack of preparation – Developing a profitable trading strategy and following its rules requires strong discipline and preparation. Without proper education and practice, prop trading will become gambling and not trading
- Not reading all the prop rules and risk limits – carefully reading all the challenge rules is a must not to miss something important and get disqualified
- Underestimating the importance of win rate and risk-reward in trading – risk-reward and win rate are two key criteria for reaching the profit target of the prop firm
Monitoring and Adjusting Your Strategies
There are two things to consider when trying to use a trading strategy profitably. One is to stick to your trading plan and execute its rules flawlessly, and the other is to constantly monitor and adjust your plan depending on the ever-changing market conditions. The webs way to implement both at the same time is to always follow your strategy, and review its performance after every 25–30 trades. This number of trades is enough sample size to check whether the strategy is profitable or not.
