A road map of modern “prop” trading.

Most of the firms are now in both Chicago and New York. There are a few types. Before getting to the types it is worth noting prop trading in reality it is more market making than speculation these days.

1. HFT- to get into these firms you basically need a PhD in Computer Science. They are automated market making firms that hire PhDs to build algos to make markets. You get a salary and a bonus. You spend your time tinkering with the “market microstructure” models to try to figure out how to get filled on the bids and offers (execution is king, the actual algos are not exceptional). It is fast becoming a nuclear arms race of technology that costs so much most are ducking out. So expect a slew of engineers and other computer geniuses to be out there looking for work soon.

2. “Prop firms”- these guys label themselves prop firms but they are really making markets and want their traders to be very active (trade a ton of times a day). Any time the prop firm cares how much you trade in a day it is a red flag that their primary goal probably isn’t your speculative success as a trader. These guys are essentially either charging their traders a higher commission rate than they pay and/or are earning rebates on trades. They might have desk fees too (costs to work there). Young traders work around the clock to “prop trade” in hopes of making it big as the firms don’t want to pay the millions it takes to support the automation infrastructure. Almost everything is done as a spread trade to ensure minimal capital risk to the firm (in theory spreads are less risky). In higher volatility periods these strategies worked well, with volatility down (especially in rates) the wells have dried up.

3. “First loss”- These guys pretty much guarantee you fail. They want you to put money down against their capital. This can go as high as 30 to 1 leverage intraday. So basically a 3% move and your money is wiped out. These are called “first loss” because your money goes first (meaning the trader). So if you put up $100k and they give you $2.9mm you now have a $3mm portfolio. Giddy up, Yee Haw. Only problem is if that portfolio moves 3% the risk manager shuts your position down and you have to put in more capital to keep playing. These firms usually own a broker dealer (BD) and you trade through their BD so they get the commissions. So in reality, they are offering a loan (without capital risk if their risk manager is alert) that enables you to pursue the dream of vast riches with a leverage ratio that almost ensures the opposite while they collect 30x the commissions they would have been able to otherwise. The potential benefit here to traders is these “loans” are a way to get around reg T margin in stocks. In futures you are basically just adding leverage to leverage and almost guaranteeing you blow up (if anyone out there knows how to survive over time with 30x leverage or more as a speculator please tell me).

5. CTAs- these are the hedge funds of the quant world. If you didn't win a math olympiad as a kid you probably won’t get a callback and might want to save yourself the 5 minutes to send the resume. If you can find a firm that is not incredibly lean in terms of staff and is actually hiring my understanding is they are legit. You get a salary and a bonus/performance rewards if your contribution works. It likely won’t be a split as high as a prop firm but your firm will be charging a management fee and an incentive fee so you’d survive the lean years with some income and probably won’t be blown out too quickly.

6. Backers- there are still some legit speculators out there (price takers). Usually the deals are a little hairy though. You have desk fees associated with being there and depending on the firm there can be clauses where you end up owing some money if things go south. Often times the risk limits are stringent to the point that earning a living will take some years as you have to build up goodwill (and $$). They tend to be more realistic about risk taking (versus market makers) but if things don’t go well from the get go you’re probably not going to be loving life/there for long. In short, they are speculators but their deals usually all have some kind of hair on them. Also it is hard to know if you will find a legit situation or be miserable until you are in the belly of the beast.

At least for now, it seems gone are the days of finding a firm that allows a salary of some sort and the ability to actually speculate in markets as part of a team.