One of the key tenets of due diligence in financial trading is not just finding reasons to invest but also reasons to stay away from a financial choice that could ultimately cause more problems than benefits.
Starting a prop trading firm can be an exceptionally exciting endeavour, with a lot of freedom to experiment with trading strategies outside of the limitations of rules and regulations set by clients or by working for other firms.
This is often the biggest motivation for creative, skilled traders, and it can lead to a lot of excitement. However, fools rush in where angels fear to tread, and whilst starting a prop firm can be the right decision for a lot of traders, it is not right for everyone.
There are several articles out there about why you should start a prop firm and what the main benefits are, but in the spirit of due diligence and to allow people to make the type of considered decision that will help them succeed when they start a prop firm, here are some circumstances where you should not start one up.
If You Are Not Willing To Invest In Technology
Prop firms are famous for their innovative market approaches, and a successful trading strategy requires bespoke hardware and software in order to make it work.
A successful prop firm will require software that is dedicated to helping them maximise their trading strategy, ensure they are employing suitable risk management, and provide a way to recruit other traders to follow the fundamentals of the company.
This requires powerful hardware and a data centre to manage and process the endless financial data that comes from the market and helps you to keep on top of all of the data points that help you make the right decision and understand all potential outcomes.
If you are not willing to invest in that technology, starting a prop firm is probably not the right decision for you.
You Are Not Taking Risk Management Seriously
The key benefit of prop trading is also its biggest drawback; you get 100 per cent of the benefits of trading but also assume 100 per cent of the losses at the same time.
When managing client accounts, the margins are slimmer because ultimately a trader is not using their own money to invest and is operating within strict limits to avoid losing a client’s money unnecessarily.
With a prop trading firm, there is a lot more scope to both make money and lose huge amounts through high-leverage and complex trades. It is always important not to trade more than your firm can afford to lose and to diversify your portfolio as much as possible so one bad trade does not completely ruin your business.
This is orders of magnitude more important once you start recruiting other traders, and you need to have a codified trading strategy and risk management protocol set up to ensure that your initial capital is not wasted on bad trade after bad trade.
Similarly, it is about knowing what leverage truly means, and how to ensure that you make the most money whilst accounting for the possibility of failure and ensuring that it does not lead to ruination.
You Are Prone To Emotional Trading
As with any other business, starting a prop firm can initially be very stressful as you gather the initial capital together and start making trades that are critical to the future of the business.
It can be very stressful to account for these losses, and this is the primary reason why prop trading is not for everyone either working for a prop trading firm or setting one up.
If you can get past that, trust your strategy once it has been robustly developed and set up, and not take individual gains and losses too heavily, a prop firm will start to reveal many of its benefits in terms of flexibility and in terms of potential profits.
You Are Unwilling To Keep Up With The Market
Prop firms have the flexibility to shape financial markets, but this requires a lot of work and a lot of research.
Some of this can be helped with software, and as a prop firm becomes more established it will develop systems to ensure that it keeps on top of market events and world events that can shift relevant financial markets, but it is something important to be mindful of.
It is also about being unwilling to believe that markets and circumstances have the possibility to change; Long Term Capital Management famously collapsed as a result of making one big assumption regarding how nations with monetary sovereignty manage their debt.
