Happy new year everyone, I hope you all had a pleasant time and aren’t struggling too hard with the January blues. To kick off 2024, we have two very topical topics.
Firstly, we have a new podcast with Chariton Christou, Co-Founder of Boltzmann Research. Chariton was Head of Quantitative Research at Tickmill and spent close to seven years working on the company’s dealing desk, managing risk, and all other liquidity-related matters.
We discuss his new venture, what quants can actually do for dealing desks, common mistakes dealing desks make at brokers, what problems AI solutions are solving on trading teams, challenges brokers face given how pricey quants are too hire, and more. You can listen via the links below.
Next we look at prop trading or funded trader companies. I noticed just this morning that one large Exness affiliate has set one up. Interesting developments. Should you start one?
We consider this below. In the meantime, PropTradeTech helped us put together this article. So check them out here or via the link on the banner below if you have any questions about starting a funded trader programme.
Can brokers become prop firms?
Prop trading is not a new phenomenon but it has become increasingly popular over the past five or so years. My sense is that a lot of people in the FX/CFD industry are underestimating how big a force this already is and has the potential to be.
Some executives dismiss it out of hand but others don’t have any idea what I’m talking about when I bring the topic up. This latter group always surprises me because, given the amount of money some prop firms are making, it is hard to see how they are not showing up when brokers do competitor analysis.
Despite this, some brokers are moving into the space. Axi is probably the most noteworthy. But others have either been set up by existing brokers or established by executives from within the FX/CFD world.
I think more are likely to do it. But there are some things to be wary of.
What is prop trading?
Before continuing it’s worth defining what we are actually talking about. ‘Prop firm’ can be a slightly misleading term, as people can end up thinking you’re referring to a few guys trading futures with their own money.
The prop firms we are referring to here follow a different model and bear some resemblance to old school futures arcades. In simple terms, a trader pays money to take a ‘challenge’ or ‘test’. All trading is undertaken on a demo account, meaning no client funds are held and no real money trades are placed in the market.
Assuming the trader passes that challenge, the prop firm then allocates the trader an earnings account. Any profits the trader subsequently makes in this earnings account are split between the company and the trader, with the latter’s allocations typically increasing the more they deliver consistent profits.
Starting a prop firm – not that simple
In theory, the technological components needed to make this happen should sound familiar to broker executives. That so many of the prop firms that have come to market thus far are operated by executives with e-commerce backgrounds, with limited financial services experience, should also mean broker executives looking to start a prop firm have something of an edge over the competition.
That latter point does remain true but the actual practice of setting up a prop firm can be something of an ‘uncanny valley’ experience when compared to running a broker.
“I would say that many executives we’ve helped come to market have found the process a lot more difficult than they’d initially expected,” said Marcus Fetherston, Director at PropTradeTech, a technology company that provides end-to-end solutions for prop firms. “There can be multiple reasons for that, but we typically see difficulties around customer service, tech and pricing.”
Prop trading CRM
With regard to dealing with clients, the manner in which challenges are structured mean that backend CRMs and client portals need to be more sophisticated.
Clients need to be able to see in real time how they are performing against the targets they need to hit and their own trading activity has to match up with that.
“The basic problem is that you cannot use a generic forex CRM for a prop firm as you have to capture and respond to data in a more complicated way than a broker would,” said PropTradeTech’s Fetherston. “You need to be able to see that on your own backend, but also to automate the end-to-end client experience – so a client breaking the challenge rules would be one obvious example.”
Prop firm pricing model
Another key factor is the pricing model. Most brokers will have a rough idea of the lifespan of their own clients and how retention works.
For prop firms the process is quite different. A client paying for a challenge pays up front. That money is also not a deposit, it’s paid directly to the prop firm.
The upside here is that there is more predictability in revenue. The downside is it’s more subject to the price elasticity of demand than a broker business – a deposit has no cap on it, whereas a specific challenge is always going to cost the same amount. However, and contrary to what I expected, this is apparently not impacting retention.
“We have helped a lot of props with their pricing models,” said PropTradeTech’s Fetherston. “These need to be formulated carefully. But what we see is that a high proportion of clients reactivate with almost no input from the marketing team at the prop firm. A lot of that is related to the communities that props build online.”
Aside from pricing them, prop firms also have to think about how they can structure challenges to prevent fraudulent activity from taking place. One simple example is just putting in minimum trades or trading days. This can stop someone from doing a two way trade simultaneously and then holding on to their winning position. However, this is arguably one area where brokers have some experience.
According to PropTradeTech, many of their clients are seeing the same sorts of arbitrages and simple scams that were common a decade or so ago in the FX/CFD space. Whereas brokers are now fairly accustomed to dealing with these, many prop firms are not, as their founders tend to have no background in the brokerage space.
Attracting and managing prop firm traders
The final areas that brokers thinking of starting a prop firm should be aware of, given they are not the same as in the brokerage sector, are marketing and customer relations.
With regard to the former, the average client age for prop firms has, at least thus far, tended to skew much younger than in the brokerage space. Whereas FX/CFD clients tend to be in their mid to late 30s, prop firms have tended to attract younger clients in their 20s.
A huge amount of the marketing has also taken place on things like Discord and other chat room-type applications. This is obviously not uncommon in the FX/CFD broker space but it seems to play a far bigger role in the prop space.
Once clients are onboarded, another area that PropTradeTech noted as being significantly different from the standard FX/CFD broker operation is client relations. This is mainly because, from the prop firms side, there is less of a need to activate clients or discuss markets with them. However, the number of technical requests and complaints can be vast.
“I worked in broker ops for a long time and can tell you that prop firms are so different in this respect,” said Fetherston. “The volume of requests you will get is so much higher. You can reduce this with the right technology but it has the potential to create headaches. Someone that churns out slowly at a broker is much less likely to start calling you up or writing complaints, relative to someone that feels as though they failed a challenge unfairly.”
So there you have it. You can start a prop firm – but don’t think it’s exactly the same as running a broker.
