Prop shop trading vs. hedge fund trading
I have read on multiple forums on this site that good prop shop traders can rake in large bonuses upwards of 500k after only a few years. Is this actually true? I haven't heard the same about hedge fund traders but I've always been believed them to make the most.
- What are major differences between prop shop traders and hedge fund traders (lifestyle, strategies, compensation, etc)?
- If prop shop traders make more than hedge fund traders, the good ones that is, then why would one prefer trading at a hedge fund over a prop shop? (I understand that trading compensation is performance based, but I never hear anything about hedge fund trader compensation)
How Does Compensation Compare at HFs vs Prop Shops?
For all our prop shop questions, insight from retired Certified Sales and Trading Professional @derivstrading" has proved invaluable. Here is how he assesses prop shops vs hedge funds.
Prop Shops
- In general are smaller and more nimble.
- They try to extract nickels from all over the place due to inefficiencies (some do it with statistical models, some with speed of execution etc). That is why you usually find prop shops in liquid and exchange based products such as options and cash equities for example.
- They tend to have very low overheads and capital requirements and are therefore usually seeded by the guys that started it/run it.
- There aren’t outside investors such as pension funds.
Therefore the absolute amount of money might not be huge compared to HF's but it stays in the firm. If you have an HF that has 1bln of capital and they make 20% or 200mln, they get to keep 40mln in performance fees for compensation. For a self funded prop shop with no outside investors, to get the same comp payout in total for the same 20% return on capital you would only need 200m of capital. Prop shops tend to be smaller however but you can see why payouts can be quite high for them.
Hedge Funds
So why don’t traders want to go to prop shops as opposed to HFs? Well in general it’s a very different investing style.
- HF traders (not execution traders as that’s a completely diff thing) are more akin to portfolio managers in terms of skillset.
- They know how to put on positions and manage a book of risk that has a mixture of ideas that have a target time frame of a couple weeks to couple months, whether this is in global macro, L/S equity, CB arb etc.
- In general HFs are bit more to what most people would call investing whereas prop shops are more trading oriented.
Recommended Reading
- Prop Trading Firm vs a Hedge Fund
- Top Prop Hedge Fund Traders Strategies (Discussion)
- Hedge Fund Careers: Guide to Landing a Hedge Fund Job Out of Undergrad and Beyond
- Q&A: I’m an Algorithmic Derivatives Trader at a Chicago Prop Shop
- Q&A: I’m an Equity Prop Trader
- Which Prop Trading Firms Have the Highest Salaries?
For one, prop traders are more involved in the decision-making process than hedge fund traders who are mainly execution traders.
There is a huge spectrum for a lot of the stuff you are asking about, so I will try and generalize a bit so keep that in mind.
Prop shops in general are smaller and more nimble, and try to extract nickels from all over the place due to inefficiencies (some do it with statistical models, some with speed of execution etc). That is why you usually find prop shops in liquid and exchange based products such as options and cash equities for example. They tend to have very low overheads and capital requirements and are therefore usually seeded by the guys that started it/run it. There arent outside investors such as pension funds. Therefore the absolute amount of money might not be huge compared to HF's but it stays in the firm. If you have an HF that has 1bln of capital and they make 20% or 200mln, they get to keep 40mln in performance fees for compensation. For a self funded prop shop with no outside investors, to get the same comp payout in total for the same 20% return on capital you would only need 200m of capital. Prop shops tend to be smaller however but you can see why payouts can be quite high for them.
So why dont traders want to go to prop shops as opposed to HFs? Well in general its a very differnet investing style. HF traders (not execution traders as thats a completely diff thing) are more akin to portfolio managers in terms of skillset. They know how to put on positions and manage a book of risk that has a mixture of ideas that have a target time frame of a couple weeks to couple months, whether this is in glboal macro, L/S equity, CB arb etc. In general HFs are bit more to what mos tpeople would call investing whereas prop shops are more trading oriented. Whereas on the other hand prop shops tend to operate on a smaller scale (read the lower capital need) and will try to squeeze out smaller profits much more often via quicker trading. If you have 20 traders each making 20k euro/day consistently, thats 100m at the end of the year, whereas 20k a day is a rounding error for most HF desk (hence the saying 10k a day keeps HR away...).
Obviously this isnt black and white, there are a lot of stat arb HF's that do more akin to what a prop shop would do, but thats the idea in general.
Hey derivstrading , great response.
Just a question about this, though. Could you provide a couple examples of each because I'm failing to see some of the differences. For example, something like Citadel, DE Shaw, Jump.. they would all be considered prop shops, correct?
Then where are these hedge fund traders sitting? Are they are firms like Balyasny, Point72 etc, BlueMountain etc?
I guess I'm just a little confused on the titles. A little explanation would be great.
I think Jump is the only one you listed that is a prop firm.
I'm guessing prop shops have very low job security and solely based on performance, right?
Citadel also is has a proprietary trading arm.
Keep in mind that there are a wide variety of prop shops. There are the 'bucket shops' prop shop where you have to play with your own money (the firm provides margin) and pay your own fees for your trade. Some people are able to survive and make money, but as you can expect, a lot of people wash out of them with less money than they came in with.
Then there are the 'elite prop shops' that are almost like tech startups. They hire a very large amount of devs and try to squeak out a technological advantage over their rivals. The job security is not as bad as you think, as it is hard to fuck up arbitrage. The hard part is getting in, as they hold a high standard for their hires. Base pay for new hires competes with tech, bonuses are very generous, and the work life balance is reasonable.
In addition the type of trader that might excel at one company could do horribly at a different company. Some prop shops don't hold a position, other shops think a 60% batting average is very good. In other shops the biggest bonus might not even go to the best trader, but to the guy who figures how to shave of microseconds off of their systems.
I think your question is misguided; both are generally the same. Someone gives you money to trade, and you need to make money on it.
Either you can, or you can't. Most can't.
Can you earn $500K profit on a trading account of $5 Mil.? If so, it doesn't matter whether you're at a prop shop or hedge fund, you'll make your $500K
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