prop shop Archives - Algorithmic and Mechanical Forex Strategies

Leverage is the rope with which most forex traders hang themselves. Yet, when this powerful tool is used carefully it greatly improves trading performance. In fact, prop traders can use maximum leverage for the best gains while also minimizing risk; below we’ll describe how Shaun does it.

Legacy risk-management strategies

Most traditional forex risk-management strategies are based on either limiting the amount of loss per trade or per market as a percentage of the account’s equity, or else tightening the parameters of trades going forward based on current losses.

Most traders typically increase or decrease their degree of leverage and position size according to wins or losses over some period of time.

Max leverage for minimum risk

Yet, even though it may seem counter-intuitive, savvy prop traders use maximum leverage to minimize risk. It’s true – Traders like Shaun use leverage to minimize at-risk capital while maximizing the compounding power of a series of winning trades while using a good system.

How? By limiting the amount of money allowed to accumulate in the brokerage account during the monthly trading cycle.

Throughout the month, a successful trading system harvests gains from the marketplace. Most traders allow those gains to accrue and use them to trade ever-larger lot sizes, even while using the original system and risk-management strategy. During a winning streak by any given system, the results can be impressive.

Of course, the trouble is that nearly all trading systems, if operated over a sufficient period of time, will “blow up.” When a system “blows up,” it can lose the majority of the trading account equity very quickly. That is, the system fails to the extent that it either runs out of money or the original trading rules must be significantly modified.

How? By limiting the amount of money allowed to accumulate in the brokerage account during the monthly trading cycle.

Exacerbated by leverage, the occasional system failure is what keeps most traders poor. During a period of deep drawdown, weak traders go out of business because they lack trading capital. They haven’t put anything aside for “seed” funding.

Manage risk by sweeping excess cash from the account each month

To reduce both the technical risks of a trading system failure as well as the psychological pressure of facing drawdowns, Shaun and other prop traders “sweep” excess cash from trading accounts each winning month, so that the months’ beginning equity balances are all the same.

Keep the least amount of money with the broker

That limits the total risk in case of a blow up to a maximum of only a single month’s preset trading account limit. Gains from previous winning months are safely sequestered in a different account, away from the trading account.

“Prop shops” minimize risk under leverage

Proprietary trading firms generally use sophisticated risk-management systems to monitor individual risk management and prevent monthly drawdowns from exceeding threshold levels.

Everyone wants to make sure prop traders manage risks effectively while leveraging their own capital, as well as the firm’s money.

Risk every dime in the account, each month

When a system works well, traders like Shaun leverage their capital to maximize gains and trade the largest practical position size. The profits from a string of successful trades can accumulate exponentially.

And, to ensure gains are protected, each month Shaun “sweeps” any gains from the trading account, reducing it to its predetermined par level. It’s critically important to pull profits on a regular basis, so they won’t be subject to loss.

Whenever a losing month does happen (and it will!), you top up your balance. The idea here is that instead of trading a $50,000 account, all of which is subject to loss, you only put something like $5,000 into an account. That’s money that you’re truly able to lose.

Are you happy if you lose it? Of course not. But as a risk-focused trader, you know that even if you lose the money, your financial situation shouldn’t be severely impacted.

$5,000 probably isn’t the exact number for you. Maybe it’s more. Maybe it’s less. The point is, once you know your max loss number, it’s a lot easier to kiss it goodbye and put it into the account. Then, if you get the performance that you’re expecting from your trading system, the return on investment (ROI) can yield some eye popping numbers.

This chart is the Myfxbook verified performance of my trading account.

If you’d like to learn about pulling profits from your account and other prop trading tips, stay tuned for the next article in this series.

Shaun’s been attracting plenty of attention based on the recent performance in his high risk account, which parallels a proprietary trading scenario. Sometimes also called “prop trading,” the term generally refers to a range of opportunities offered by an investment fund or speculative firm to individuals who trade for the firm’s account.

For traders who have a real talent for forex, yet very little capital of their own, prop trading may be the pathway to a good career or supplemental income.

What is proprietary trading?

To avoid confusion, it’s important to understand that the same term is also used in a different context to refer to the basic concept of any brokerage firm or financial institution that trades in-house for its own account, in addition to processing trades for outside clients of the institution.

In effect, that firm seeks to profit from successful trades rather than commissions from clients’ trades.

Yet, independent traders generally use the term proprietary trading to describe a relationship by which they trade funds for a smaller, more speculative investment firm. In short, the traders use the firm’s money to apply their own strategies, and if successful the firm shares the rewards with the trader.

A “prop shop” is a proprietary trading arrangement with a group of individuals who trade electronically, either at the firm’s facility or in independent trading offices using the firm’s resources. Prop shops provide their traders with the resources necessary for success, including education, capital and trading platforms.

Prop shops have their historical foundations in banks’ proprietary trading. Traditionally, banks and brokerages would make a market in securities and derivatives in which they held positions, in order to facilitate liquidity in the marketplace.

Over time, financial institutions’ in-house traders developed their own proprietary strategies and systems, hence the name.

How prop trading normally works

There are a wide variety of prop trading programs offered by various funds and financial firms. Most do not require the trader to invest money, although some offer prop-trading courses or other educational purchases as part of a package.

All prop shops use performance metrics to monitor trading results and apportion compensation. Traders who have winning forex systems are usually allocated trading capital beginning at $100,000 and well-proven traders often trade far larger proprietary accounts.

Prop trading scenarios require the applicant trader to show early promise of successful trading ability. Some proprietary trading companies use a “farm team” approach by requiring applicants to trade demo accounts online and then selecting the best candidate traders.

Others accept applicants into their trader-education programs which ultimately lead to proprietary trading accounts for the traders who excel during the training phase.

For beginners who show potential, the prop shop usually offers plenty of mentoring and education, as well as technical and psychological support.

In a prop shop, it’s up to each trader to prove his or her ability to consistently squeeze gains out of forex markets. Over time, the successful trader receives progressively larger allocations of capital. So, the trader’s potential income likewise grows.

How does this apply to Shaun’s trading? Tune in for next week’s article, where I’ll cover the biggest mistake most traders make.

Maximimum Leverage To Minimize Risk