Prop Trading Explained
Proprietary trading occurs when financial firms such as investment banks, hedge funds, or brokerage firms choose to trade for direct market gain rather than seeking profits by trading on behalf of their clients.
These financial institutions use their own capital to execute financial transactions instead of using their clients’ money. Although risky, prop trading can prove very profitable for financial institutions as they take all the returns from a trade as opposed to just earning a commission for processing positions.
Prop trading can involve investing in stocks, bonds, forex, commodities, derivatives, and other financial instruments.
Prop trading shops often have a competitive advantage over retail investors with unique access to valuable market information to inform decision making. In addition, these institutions benefit from more sophisticated models and advanced trading software.
Investment banks such as Goldman Sachs and Deutsche Bank have been known to earn a significant portion of their profits (and losses) through prop trading efforts.
