how does prop trading compensation work?

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xdenielx

everyone says that the commission that you're company charges is more important that the % of pay that you get....how does it work if you're offered a certain GROSS %???

for example, if' i'm making 30% of my gross trading profits, then it doesn't matter how much commission i've paid because i'm being paid gross of any commissions.

can someone give me an overview of how the compensation scheme works and what i should expect to get (% of profits, acceptable commission, etc) for working at a place with no capital contribution?
 
If you have no capital to contribute and you're going prop, most firms -- nowadays -- will bring you in and teach you scalping. Something mechanical and uninformative like stepping in front of size (bids and offers), and holding for very short periods of time, or liquidity trading, which is almost dead. They do this to limit their, and your, risk while forcing you to generate lots of commissions.

They also often make you sign a non-compete agreement, stating that you cannot trade anywhere else for a year or more, lock you into a low payout, and charge you anywhere from .0075 to .01 a share, which no experienced trader would ever pay. They do this because they know most people fail, so they want to lock you down and make sure you make as much money for them as possible before you quit.

Generally their cost basis to cover their fixed clearing costs is .002 per share, depending on how large they are.

Most people after half a year end up doing 30,000 to 50,000 shares a day. So at .01 a share that's $300-$500 a day, without SEC fees, ECN markups, and other charges, which often bring it to $400-$600 a day. After that is deducted from your gross profit, if you ever have anything left over (which is rare), you get a percentage of that at the end of the pay period. Usually you get 50%-70%. The firms keep everything above .002 and their percentage cut as profit for themselves. You cover your own losses.

It is extremely profitable for LLCs to bring in new people to teach them this method, offering nothing beyond that, and then kick them out the door. It's very low risk. After you give them free labor for a year or two you decide if you want to continue once you have begun to understand how the market operates.

This business model makes it very hard for undercapitalized traders to succeed. You have to be very disciplined and intuitive to pick it up enough to survive a few years without digging a huge hole, or you have to have the capital to sit it out for that time and observe, observe, observe.

Only the higher-eschelon prop firms actually teach you something and have a real stake in your success, and they do not regularly recruit without a big process. So just be aware of this now, so that when you sign an agreement you understand precisely what your labor is worth.
 
thanks for the info, very informative...one question though:

The firms keep everything above .002 and their percentage cut as profit for themselves. You cover your own losses.

I didn't think that you cover your own losses? I thought that they cover the losses, but if you're losing they give you the boot? You mean that if you lose their money you actually have to dig into your own pocket and pay them?

Also, how is this a successful business model? In the end they're hiring inexperienced traders to trade with their money? Is it because they keep you around only if you're making money, and then they make money off the commissioin?
 
Quote from xdenielx:

thanks for the info, very informative...one question though:

The firms keep everything above .002 and their percentage cut as profit for themselves. You cover your own losses.

I didn't think that you cover your own losses? I thought that they cover the losses, but if you're losing they give you the boot? You mean that if you lose their money you actually have to dig into your own pocket and pay them?

Also, how is this a successful business model? In the end they're hiring inexperienced traders to trade with their money? Is it because they keep you around only if you're making money, and then they make money off the commissioin?
More...

I believe he was referring to where you have your own account. I think the firm will limit your losses since your putting up no capital at all, you actually are trading that firms capital.

They hire inexperienced traders to churn and burn. They may lose 50 - 100 dollars a day, but traders may generate much more in commissions. If you are a good trader, you are making money, and they are still making commissions. No matter what happens to you, they make money, it's a brilliant idea for them. It's a successful business model for the brokers, prop firms.... etc....
 
Quote from xdenielx:

thanks for the info, very informative...one question though:

The firms keep everything above .002 and their percentage cut as profit for themselves. You cover your own losses.

I didn't think that you cover your own losses? I thought that they cover the losses, but if you're losing they give you the boot? You mean that if you lose their money you actually have to dig into your own pocket and pay them?

Also, how is this a successful business model? In the end they're hiring inexperienced traders to trade with their money? Is it because they keep you around only if you're making money, and then they make money off the commissioin?
More...

Actually I should clarify. Luckily you don't have to go into your own pocket to pay them once you start losing money. But they take commission no matter what. Most inevitably end up in the red for a long time, possibly several thousand dollars, when in reality that debt doesn't exist and they are making hundreds a day off of you. Most young guys I've seen experience a lot of pain from this, thinking that they're losing the firm money and creating a hole from which they can never climb out of, and that further influences their trading.

It's successful because one or two guys figure trading out well enough after a few years and stay with the firm, when they drop their rates to .003 or .004. The rest provide regular income for the firm and then leave after several months to a few years, once their non-compete is up and are allowed to shop around and get fair, competitive rates from other firms. Or they just get fed up.

If you are offered a .0075 rate, and ESPECIALLY if you have to sign a non-compete, just know that this is what they want from you, and they will keep you at that rate for a long time to earn them a ton of money off of your free labor.
 
I was thinking of checking out the prop market, as I've traded on my own for years now quite successfully. My questions....where/what to trade
Futures, Stocks, Options???

Do prop firms specialize or want traders doing it all, I have an offer to enter a Option firms market maker training program...goes on over a year...in europe. Any opinions on what to try out and check for...how do you now theyre not all totally unscrupulous businessmen just looking to milk young traders.
 
That said, some can make starting out in that environment. You just have to be willing to not increase your volume and just watch the market day after day, trading tiny amounts and never gambling, while reading tons of information on how to understand market mechanics. You would have to do that anyway to succeed. But I'm sure the firm will start asking you to size up after a while, telling you it's the next step. Whether or not you're able to handle the commission burden on higher volume depends on your true understanding of risk.

It's common knowledge that's how things work. I have spoken to many guys from at least 5 different firms and it's standard practice.
 
Quote from Junior Broker:

I was thinking of checking out the prop market, as I've traded on my own for years now quite successfully. My questions....where/what to trade
Futures, Stocks, Options???

Do prop firms specialize or want traders doing it all, I have an offer to enter a Option firms market maker training program...goes on over a year...in europe. Any opinions on what to try out and check for...how do you now theyre not all totally unscrupulous businessmen just looking to milk young traders.
More...

If you've traded successfully on your own you should pretty much know what instrument you want to trade.
The more specialized firms with a decent edge allow you to trade futures (rarely options). Most will have you on stocks, and particularly NYSE only, unless you're doing liquidity trading (do not ever learn liquidity trading, in my opinion. It does not teach the true principles of market movement in any way).

How do you know they're not unscrupulous? If they can delineate precisely the strategies they will teach you (Bright, for instance, has a whole list of more efficient and systematic methods for trading and training), if they will drop your commissions based on volume to a fair, competitive level, and are willing to explain all of your true costs and how much (generally) they will make off of you. Also, if they have good trainers, although I've met so many groups who pretend to train you when they just wing it and pass you off to some successful trader who isn't a good teacher and doesn't have the time or incentive to teach anyway.

Luckily I got started years ago in an exclusive group at a small place with people I knew from school. If you can find people you really can mesh with, understand, and trust it's a great opportunity.
 
Thanks for the reply...yeah I've almost exclusively traded only Nasdaq and Amex Equities. Does anyone know what the whole biz is...for Option MM's hiring new traders to teach to be MM's...it seems like quite a lot of training as well...
 
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