Proprietary trading firms, or prop firms, are gaining popularity amongst aspiring traders as a way to gain access to capital without jeopardizing their own finances. These firms pay traders for their services and allow them to keep a portion of the profits generated from their trades. With so many prop firms available, the myriad of terms and conditions related to their funding structures can be overwhelming. While some of them provide instant funding, others require an aspiring trader to pass a funded account challenge. This distinction raises the question: why do some prop firms provide instant funding, while others don’t?
Understanding Prop Firms and Their Funding Models
Before analyzing the specifics behind varying funding models, one must understand how exactly prop firms operate. Essentially, prop firms allocate capital to traders with whom they enter an agreement to share the trading profits, and, if applicable, the losses. Prop traders are generally expected to adhere to a set of rules that control risk management, profit sharing, and several other factors that influence business operation. The most common setup is that the trader retains a fraction of the profit he brings and the firm is responsible for the loss.
Traders’ accounts can be funded in several approaches, with two common ones being ‘instant funding’ and the ‘funded account challenge’. With instant funding, traders are given capital right after joining a prop firm. In contrast, the funded account challenge has a series of prerequisite proofs of skills like tests or specific achievements that traders need to complete before funding is awarded.
Instant Funding: The Appeal to Traders
The appeal of instant funding is something that simply cannot be ignored by numerous traders. From their perspective, having the ability to start trading with actual money at once is incredibly alluring, and looks like a quick and easy way to make profits. As a result, some of the best prop firms for day trading offer this model because it eliminates many barriers to entry and allows the trader to get started right away. What motivates these firms to provide traders with instant funding?
Removing Steps of the Process
For prop firms, instant funding serves the purpose of accelerating the onboarding process. Rather than making traders attempt the exceedingly monotonous and often painfully tedious challenge of clichés, prop firms utilizing instant funding make the onboarding process much easier by qualifying traders based on their credentials and prior activity. For some seasoned traders who possess a robust trading history, this sophisticated model can be attractive because they can gain access to funding more quickly.
Firms providing instant funding may target experienced traders with a track record of profitability. These traders are confident that they can manage risk, meaning the firm will not have to go through the extra procedure of a funded account challenge. In these instances, instant funding serves as a motivator to acquire skilled and professional traders who need little to no time to begin trading with real capital while turning profits for the firm and themselves.
Quick Earning Potential
Traders and firms can begin to earn instant profits. With no qualification challenge, traders can instantly access the markets and the firm can start earning from the trader’s success. This is great for firms trying to scale their business because it allows for quick onboarding and revenue generation with immediate access to traders who can perform from day one.
In an ideal world, instant access to funds from a trader’s perspective means the ideal scenario for fast returns. If a trader has a well-structured trading plan and can execute it consistently, he will be able to use the firm’s capital to earn tangible profits in real time instantly.
The Funded Account Challenge: The Motivation Behind Some Prop Firms Use It
All prop firms seem to operate in a similar manner. They grant traders access to capital only after undergoing a funded account challenge. Such challenges contain multiple performance milestones or tests that require traders to be profitable within restrictive risk parameters. Most challenges offer some form of protection and the prop firm must ensure participants are capable traders before trusting them with the firm’s funds.
Risk Control
Limitations set on a trader’s account can serve as motivation for a firm to achieve a funded account challenge. For one, they allow a prop firm to strip abusive trading rights while mitigating any risk exposure simultaneously. These firms are allocating their own equity to traders and as such, need to be confident in the candidate’s ability to sustain and not lose money either through lack of control or extreme disciplined trading. Meeting the requirements of a challenge will give confidence to the trader that they are able to function sustainably within the confines of effective risk management.
A trader’s performance during the challenge facilitates understanding of their trading approach and their risk management. Firms that implement challenges are often more careful about allocating larger amounts of capital to traders who, at least on paper, don’t possess these skills. The challenge in this case is meant to filter out traders who do not meet the predetermined thresholds to access capital. In this manner, the funded account challenge limits the extent to which a firm could incur substantial losses from unprepared traders, thereby protecting the firm from severe financial damage.
Fostering Responsibility
Accountability is another aspect that the firms seek to instill in traders by incorporating funded account challenges. These criteria encourage discipline as funded accounts are only awarded after demonstrating consistent effort in the challenge. Traders who complete successful challenges prove that they can adhere to a trading plan, contain risk, and implement their strategy at multiple points in time.
Both achievement and accountability elements are included in the initial challenge. Traders understand the objectives that need to be accomplished in order to receive funding and work towards them systematically which is more goal-oriented. Such responsibility makes it easier for the traders to concentrate which is beneficial for both the trader and the firm.
The Advantages and Disadvantages of Funded Account Challenge and Instant Funding
Both types of models, sponsored account challenges and instant sponsorship, have benefits and drawbacks associated with them for both companies providing them and traders looking for capital.
As far as traders are concerned, instant sponsorship is super convenient as it provides immediate access to funds without needing to demonstrate any prerequisites. At the same time, however, instant funding has its own downsides. Some traders, once having access to capital, tend to be undisciplined or lack effective risk management techniques and can harm themselves financially. Not using funds wisely can lead to quickly depleting them, which could financially ruin the trader as well as damage their name within the firm.
Conversely, the funded account challenge presents a notable opportunity for traders to showcase their abilities and prove that they are capable of managing capital sensibly. Nonetheless, the challenge can be tedious and taxing, particularly for novice traders. Most often, these challenges have accompanying performance requirements, and for some traders who are on a losing streak, this can be quite stringent, particularly if they are having difficulty managing discipline and maintaining composure under pressure.
With prop firms, offering instant funding can serve as an effective marketing tool for attracting highly skilled traders, enabling swift profit generation. However, if the firm’s trader vetting process is insufficient, the firm exposes themselves to significant risk. In contrast, the funded account challenge enhances risk evaluation and management capacity by limiting funding to the traders deemed most competent. Although this improves risk mitigation, it increases the likelihood of slower capital accessibility for traders, which could lead to lower participation rates from traders eager to access funding.
Conclusion
From our analysis, the difference between prop firms and instant fund traders and those who use the funded account challenge boils down to the firm’s tolerance of risk and how they evaluate traders. With instant funding, there is tempting access for experienced traders who want to start trading off the bat, however, it comes with risks attached to both the trader and the firm. The funded account challenge, on the other hand, offers a more process-based, less risky approach for firms to evaluate traders’ competencies before extending capital to them, albeit it is lengthier for the traders.
Both methods aim to achieve the same end goal, and the leading prop firms for day trading are those that manage the risk of attracting skilled traders. Be it the desire for instant funding or a willingness to undertake a funded account challenge, knowing the different available funding models helps traders make educated decisions on which prop firm to partner with.
Michael Caine