Business models of prop-shops?
- Thread starter mizhael
- Start date
Quote from Maverick74:
I'll tell you where firms make their money. Believe it or not, it's not from commisons anymore. Don makes some decent coin on the training fees (boot camp) etc. But the real magic is the lending of capital. Don can borrow money from GS for almost nothing now. Same goes for most firms. And they charge interest to the traders for leveraging that money. Now I know what some of you guys are thinking. How much can Bright or any firm really make on interest.
I'll tell you. I'm going to use Bright as an example so as not to advertise my firm (you're welcome Don). Let's say Bright has 20 million in capital. And let's say through all the various pairs they trade they are able to deploy all that capital to their traders. Goldman will lend Don 6.5 times that 20 million in the JBO. That's about 120 million. Let's say Don can make 500 bp on that spread. That's a cool 6 million for swapping cash from a master account to a sub account. Let me put this another way. On that 20 million, they are earning 30% a year interest on that money almost risk free. Try getting that rate at your local bank.
As the old saying goes, good work if you can find it.
ps Bright is making more then 500 bp on that spread. I was being very conservative.
Mav, I thought you said Bright's model (equity trading) was a dying one and there was no money to be made. Sounds like he is doing just fine.
Many of the people that sign up probably know at some level that the training is a waste of time and money and recognize that it's an excuse for the prop firm to charge some up front fees. They're just hoping that sitting next to an actual, real, profitable trader, will help them turn the corner and make it to the promised land of consistent profitability. Notwithstanding, the prop firm isn't going to give them anything they don't already have or can't find a cheaper alternative on their own.
Direct access trading and low cost commissions have disrupted the business model for prop firms. They're buggy whip manufacturers in a world in which horse drawn cars are rapidly being replaced by automobiles. The business model needs some adjustment to remain viable.
Believe you me, the Bright's made a fortune on this business model in the earlier years. But each and every year their margins are getting tighter and tighter. One of the reasons they are pushing the education so hard I'm sure is to make up for the declining commission business. This is true at all firms. I believe in the next 5 years, all trading will be commission free. Rates are going to zero. The game is going to change. I'm sure the Brights will figure something out.
Perhaps the original post for this thread who wants to run a prop firm will find this discussion useful.
I recall Schwab had per share pricing when they had CyberTrader, and then promptly went back to the $8 flat rate model.
Zecco used to heavily promote the "zero cost" commission model, and now it's only for the first 10 trades. Wells Fargo and BofA/Merrill will offer a certain amount free trades but it's web-based, which is useless for active daytraders.
The "commission free" model thus far has not prevailed, aside from the examples above and a few commission free ETFs now being promoted. The big brokers (Fidelity, Scottrade, etc) refuse to budge when asked to offer reduced commissions such as per share pricing for smaller lots, and will not allow the retail trader to collect rebates on trades placed through their direct access software.
The big brokers could compete with Lightspeed, which has been on a buying spree lately, with their recent purchase of smaller brokers, including TerraNova (where I had my account for five years before switching to TOS). They could immediately compete with Speedtrader, which offers 39 cents per 100 shares for retail accounts, but they refuse.
What do you expect will change and cause "rates to go to zero"?
I think logically it makes sense. Brokers want your assets, not your commission dollars. Once they have your assets, there are many ways to get fees out of you. Commissions only create disloyalty from the customer to the broker.
Remember back in the day when software use to have value. Now software is given away for free because more sales can come through the software rather then from the software.
BTW, there is already one prop firm that has semi adopted this model. Cornerstone trading basically lets traders trade at cost with no markups but instead charges a monthly fee.
http://www.cornerstonetg.com/indexptg.html
You are going to see more and more firms both on the retail and prop side moving to zero commission or no markups on cost, in the future. Of course there will be other fees and charges to replace it.
On the retail side I actually can see something called variable commissions happening on the retail side where you will pay a different rate depending on what you are trading. For example, buy 100 shares of C, a thick and liquid stock and you will pay next to nothing. Buy 100 shares of a listed stock with very little liquidity and you will pay more for share. It wasn't that long ago were retail brokers actually charged different rates for limit and market orders.
Mind you I don't think this is going to happen this year, but in the next 3 to 5 years I think transactional commissions as we know them will be a thing of the past.
Sounds very plausible. The airlines did this when they started charging for meals and baggage, even after they got your loyalty in their frequent flyer program.
Wall Street relies on "transaction based compensation" to flourish, and fees are simply part of the equation, in whatever form it may take shape.
Quote from Maverick74:
I'll tell you where firms make their money. Believe it or not, it's not from commisons anymore. Don makes some decent coin on the training fees (boot camp) etc. But the real magic is the lending of capital. Don can borrow money from GS for almost nothing now. Same goes for most firms. And they charge interest to the traders for leveraging that money. Now I know what some of you guys are thinking. How much can Bright or any firm really make on interest.
I'll tell you. I'm going to use Bright as an example so as not to advertise my firm (you're welcome Don). Let's say Bright has 20 million in capital. And let's say through all the various pairs they trade they are able to deploy all that capital to their traders. Goldman will lend Don 6.5 times that 20 million in the JBO. That's about 120 million. Let's say Don can make 500 bp on that spread. That's a cool 6 million for swapping cash from a master account to a sub account. Let me put this another way. On that 20 million, they are earning 30% a year interest on that money almost risk free. Try getting that rate at your local bank.
As the old saying goes, good work if you can find it.
ps Bright is making more then 500 bp on that spread. I was being very conservative.
This is really an eye-opener for me
Bright was acting as 'broker' not a prop firm operator..bright doesn't risk any of his money or worry about managing employees etc. managing leverage etc and regulatory management etc. and taxes..
operating a prop firms requires a lot of 'management' overhead..
bright business model is a 'broker'
how will brokers make money if commissions are 'free'
commissions will never be 'free'. somebody has to pay to keep the machines rolling. there is no 'free' lunch.
free is market gimmick used by many marketers and many people fall for it including me...
the reason active traders pay low commission is because their annual commission is like $5000-$10,000/year...or more
operating a prop firms requires a lot of 'management' overhead..
bright business model is a 'broker'
how will brokers make money if commissions are 'free'
commissions will never be 'free'. somebody has to pay to keep the machines rolling. there is no 'free' lunch.
free is market gimmick used by many marketers and many people fall for it including me...
the reason active traders pay low commission is because their annual commission is like $5000-$10,000/year...or more