A couple of weeks ago we looked at the prop financial model and why some firms may be going bust.
When writing that, one of the things that became apparent was just how unclear a lot of the ‘specs’ are for individual challenges.
This was something Anton Sokolov at Brokeree also highlighted recently – basically most props bombard you with information but it’s hard to figure out what you are actually getting when you pay for one of their products.
Nothing illustrates this point better than leverage. If you go on any prop website then you will probably see something along the lines of…
Pay $100 for a challenge that gives you a $10,000 funded account. You can use leverage of up to 100:1
The question that you can never really find the answer to is whether the $10k account is already leveraged up to 100:1 or if you get a $10k balance and can leverage it up to 100:1, meaning $1m.
This matters for a couple of reasons. One is the obvious profit-making potential. If you can trade with $1m notional, that is a loooot more than $10k notional.
Secondly, props almost always set rules which dictate how large a drawdown you can have in a one day period. If you have a drawdown that is in excess of that amount, you fail the challenge or lose your funded account.
The key point is that the drawdown is typically calculated as a percentage, usually 5%, of the headline value of the funded account. So if you have a $10k account, you can only lose 5% – or $500 – of that amount.
Now you start to see why leverage matters. If your $10k account is already leveraged, and you can lose 5% of that amount, then you are not dealing with 100:1 leverage but 20:1 leverage.
But this is not what is happening. From what I see, the funded account size listed in the typical prop challenge spec is not leveraged. So if you have a $10k ‘funded’ account with leverage of 100:1, then you can trade with up to $1m notional.
But even though you would intuit that the $10k was your margin, given that is the figure your leverage is based on, that’s not the case. Your drawdown limit remains 5% of $10k – $500.
What this means in practice is that you are really using leverage of 2000:1 because if you lose any more than that $500, your account is done. So in some ways the ‘funded account’ is actually not that relevant. What matters is how much you can lose before getting closed out.