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Last month I said I’d start doing more newsletters on a broader range of topics. One of these is going to be on props.
Now I know many of you are rolling your eyes and, to some extent, I understand. A lot of the time when I look at props, I’m reminded of that old saying “people aren’t as stupid as you think, they are even dumber.”
But then I’m sure lots of other people think the same about spread bets, CFDs, crypto, and even just trying to engage in active fund management, whether it’s stock picking or doing some crazy long-short strategy.
The point is that even if you don’t like something, that doesn’t mean everyone else has to dislike it too. Just remember, there are people out there who support Arsenal, enjoy going to Coldplay concerts, or even reading the Guardian. No one is perfect!
You also have to give credit where credit is due. Like it or not, props have engaged a massive, new audience of people that probably weren’t that interested in trading before. They’ve also marketed in smart ways and added products and features that are fun and game-y. Consequently, there is no broker, big or small, that I have spoken to who has not been at least considering whether or not they can add it as a product.
Then there is the kind of raw, crash and burn capitalism that you are seeing at the moment. We are seeing a true, Darwinian, survival of the fittest process at play. That can be a lot of fun to write about. And as a great man is fond of saying, in life the most entertaining outcome is the most likely. I may as well enjoy what I do, eh TradeInformer readers?
The main reason for that crashing and burning is because there is currently no real regulation governing this industry and the set up costs are low. Turkey recently blocked some prop websites but that seems to be because they thought they were offering crypto trading, not because they were props.
And at the end of last year, FPFX Founder Justin Hertzberg – who we interviewed before – wrote a post about how prop trading should be regulated. I’m sure Justin won’t be offended when I say I disagree.
In fact, right now, if I was in prop, I would be falling to my knees and calling out to allah, god, hashem, vishnu, the Tao or whatever deity you believe in, praying that no regulator – particularly CySEC or the FCA – gets their fingers on this industry.
Why? Because 100% they will either severely knee cap it or they’ll kill it entirely. My guess is that the US would just ban it outright.
In Europe, does the track record of any regulator instil you with great confidence? At best, they will make some loose regulations that govern the industry. Bad actors will then abuse them and then the regulators will just ban the product or restrict it entirely, to the detriment of everyone else who was doing things by the book. That’s the European way.
No doubt there are bad people in the sector but when you actually look at what they’ve done, it’s typically the case that (1) they go bust from being noobs or (2) they are frauds. From my perspective, there is no need to regulate fraud because committing fraud is already illegal.
The going bust part is also significant because it points to a more interesting trait of the industry. A lot of people compare prop to binary options, which they see as inherently bad. I always think this is kind of like imprisoning a gun for murder, rather than the person who was using it. Regardless, binary fraudsters were able to ‘succeed’ because they could take someone’s entire bank account as a deposit.
Currently there is no mechanism I see where you could do the same for prop because there is no deposit – you are just making an e-commerce transaction to buy a challenge. In fact, looking at the ranking of prop prices, the most expensive challenges cost in the roughly $2k – $2.5k range. This basically means that, unlike brokers where the potential deposit is capped at how much money the person has, a prop can only make as much as its most expensive challenge.
Given this, along with the fact that no props seem to actually have sales people on the phone, I don’t think (I could be wrong) you will see the same sort of huge boiler room scams that you saw with binary options or elsewhere in other industries, like gambling.
That is not to say that you won’t have problems, but that you will not have large swathes of people losing their life savings. If you look at the My Forex Funds case, for example, there are a lot of people that lost money, but there doesn’t seem to be anyone that lost a significant amount of money because they would have had to buy >100+ challenges for that to happen.
The bigger risk actually seems to be more on the other side – that a prop has huge liabilities and is unable to pay them. This has already happened when some have gone bust. However, not paying a liability to a retail client who ultimately loses nothing, is not as bad as taking huge amounts of cash from them via a scam.
Finally, there is no doubt that many props have sucked operationally, mainly due to bad risk management. When you combine this with tiny balance sheets, bad things tend to happen.
However, lots of companies going out of business is not that unusual. About half of new hedge funds fail in their first year. In the UK, about 60% of new restaurants are dead within a year. Around 90% of startups also fail. The point is that lots of firms going bust is not unusual, it’s the norm. Regulation could change that but, as we see in the CFD market in the UK, it also kills off innovation and competition, by effectively pushing out all but the wealthiest firms from the market.
Fortunately, something regulators will have to overcome is that I don’t see exactly how you could fit this industry within existing legal frameworks, given that no financial service is being provided. Critically, no client assets are held and no securities are being traded.
My hope is that, if this industry does get regulated, it will be under gaming rules, not financial services ones. I am not an expert on gaming but, from what I see, rules on marketing, KYC, making deposits, and so on, are far less cumbersome than they are for trading.
Part of the reason for that is financial regulators in Europe are generally obsessed with client losses. The UK’s Consumer Duty rules epitomise this as they, implying in some instances that the only good product for a client is one where they make money. Make of that what you will but does it sound like the sort of mentality that would have ‘good outcomes’ for the prop business? I think not.