Efficient Capital Allocation: Improving ROI through Prop Trading Relationships

Prop trading is a popular method for traders to get funded and boost returns by opening larger positions. Trading using a funded account allows traders to access different capital tiers, often starting at $5,000 and reaching as much as $1 million or above. 

Typically, traders pay monthly or one-time, refundable fees for funded accounts, which means that they pay only a fraction of the buying power they gain access to,

This allows traders to more efficiently control their capital and boost returns at a low initial cost. 

The funding offered by prop trading firms can vary greatly depending on the skill and experience levels of the traders they are targeting. 

There are several ways for traders to improve the efficiency of their prop trading experience and make the most of the capital they have access to. 

How Can Prop Trading Improve Efficiency

It must be noted that prop trading agreements come with a whole host of requirements and limitations. These firms are looking for prop traders that can fit their requirements and trade within the bounds of the profit targets and drawdown limitations set out by the firms.

For instance, it is common for a prop firm to set a 10% profit target and a maximum trailing drawdown limit of 10% as well, which means that traders looking to get funded at the firm will have to construct strategies that are aligned with the requirements of the firm and can deliver results without violating the aforementioned requirements. 

Trading within the bounds of such limitations can improve money management skills, as well as the ability to come up with solutions to complex trading tasks, which can make trading strategies more resilient and cost-effective. 

To better illustrate how this may work, let’s look at an example of a prop trading scenario below.

Example of Efficient Capital Allocation in Prop Trading 

Suppose a trader has signed up at a prop firm and pays a monthly fee of $250 for a $100,000 account. The prop firm has these requirements in place for the relevant account tier:

• Profit target of 10%

• Maximum trailing drawdown of 10%

• Daily drawdown of 5%

• Profit share of 90%

• No minimum trading days

The trader knows that their monthly fee for the account is $250, and they must generate at least $10,000 in profits to maintain their funded account. The maximum amount the trader’s positions can lose in a day is $5,000, and $10,000 in overall loss. 

Therefore, if the trader manages to generate a 15% profit, they can keep $15,000-$1,500=$13,500. Factoring the monthly fee in the calculation, the trader generates a net profit of $13,500-$250=$13,250 for the period using the $100,000 account. 

As we can see, sensible prop trading requirements serve as capital controls that can make traders’ strategies more efficient in the long run. 

For this reason, it is important for traders to choose prop firms that have acceptable terms and services for their funded accounts, as well as a functioning scaling system to create an incentive for the trader to keep climbing the ranks to access more capital over time. 

Prop Trading Pitfalls to Avoid

While prop trading may present traders with an opportunity to boost their capital and generate more returns, there are a few important considerations that need to be made in order to avoid the cancellation of your account.

Here are some key points to consider when prop trading:

• Keep track of your daily drawdown - sometimes it is best to exit losing positions and try reclaiming lost ground in another trade than to commit and risk losing your account 

• The highest possible balance isn’t always the best - typically, high account balances come with more stringent capital controls and you should try to avoid them while you’re still new to the world of prop trading

• Make sure to use stop-loss orders - stop-losses limit the losses of your open positions, which can help you manage your daily drawdowns  

Overall, it is crucial to be conscious of the terms set out by your prop firm and to structure your strategies around them to use the opportunity to its maximum potential.