Comparing Proprietary vs. Retail Trading

After a week hiatus, Pancakes and Pivots was back this past Sunday with a new episode. And it was a really important one for new traders, as I spoke in-depth to compare and contrast proprietary trading vs. retail trading.

As those of you who are members of the Access a Trader community will know, I got my start in the prop business close to two decades ago. In fact, I spent the greater part of my trading career not even knowing what pattern day trading was. But the market and the trading business are always changing, and modern-day prop firms are hardly even recognizable compared to when I began trading. So with that being said, let’s get into some of the topics discussed in this week’s episode.

Buying Power

One of the things that’s happened in the last two decades is that there are lots of new regulations and restrictions on traders. Probably the most relevant of them for new traders, especially those fresh out of school, is Regulation T. This regulation restricts traders with less than $25,000 in capital to only 3 day-trades in a rolling 5 day period.

During the internet craze when tons of amateurs were getting into trading, the SEC and Federal Reserve Board said, “Wait a minute! These people aren’t sophisticated enough to trade… We need to protect them from themselves!” And thus, they created a bunch of legislation related to trading. I think it’s ridiculous. If I wanted to drive down to Atlantic City and put down $100,000 on a poker game, that’s allowed. But for whatever reason, the government saw it as necessary to restrict day traders. It is what it is.

Ultimately, the big consequence of Regulation T is that undercapitalized new traders will have a rough time retail trading.

I don’t agree with the restrictions at all, but to be honest I also don’t think that trading with a $2,000 or $3,000 account is really trading. It’s just buying stock, and then hoping to God that the stock goes your way because your pain tolerance just isn’t there. I don’t want to discourage new traders, but that doesn’t mean I’m going to lie to you about reality.

If I were in your position, I’d work hard and save money until I have at least $25,000 in my account to trade with. Then I’d get into retail trading. But of course, if you don’t have that capital there is an alternative option that allows you to trade with more capital right away. That’s prop firms. So why don’t I recommend that you do that? I’ll explain…

The Evolution of Prop Firms

Like I said, I got started trading at a prop firm — Generic Trading. Back then, the prop business was incredible. My first deal at Generic Trading was something like 10:1 leverage. So I put up $25,000 of my own money and got $250,000 to trade with. It didn’t make a difference because I was scared to death, but it was there for me to use. My commission structure was an 80/20 split of whatever profits I made, plus a $0.03/share charge whenever I traded.

You’re not going to see deals like that anymore, and let me tell you why. Sometime after the internet craze and 9/11, I noticed that traders were starting to shop around for better commission deals. So I turned to Ron Shear, the guy who hired me, and I asked him if I could get a better deal. He said, “You know what Dan, let me get you down to a penny per share.” So I thought wow, that’s awesome.

Gradually as more time passed, everybody in the business realized that it was possible to get better deals. We saw that we didn’t need to split all of this money with these prop firms. We could go anywhere and get a deal. So the talent pool slowly but surely started leaving prop firms. At the same time, those firms realized that they were losing all their business because too many traders were switching to retail.

What you’re left with today is a situation where there are very few prop firms even left.

At a certain point, the majority of prop firms had to change their business model. So most of them got into the educational space and started offering packages for $5,000 that teach you how to trade professionally. And hey, if they’re providing a valuable service, more power to them.

But for you as a new trader, it’s just going to be really hard to get into the prop business now because it barely exists anymore. If you can somehow get in at one of the few good firms left, cool. It’s nice to not be trading your own capital. (Of course, it’s not nice to split all your profits, but I digress.) So for the vast, vast majority of people reading this, retail trading is the way to go.

Call Your Broker

If you’re already a retail trader, I’ll tell you something very important. From my understanding, there are a lot of you guys that are still paying your broker $5, $7, even $9 per trade. And that blows my mind! You have to realize that you are the commodity. I don’t care what your account size is. And the reason that I don’t care is that I know that the clearance for a brokerage firm is virtually zero. All of the costs and fees are being paid by the retail traders, not the firms. Every time you trade, your firm profits.

So what you need to do is call your broker. Get them on the phone and say, “I’m being offered $2 per trade by [insert brokerage firm], can you get me a better deal so I can stay with you?” And you will get a better deal. Again, clearance is free. So from the perspective of your broker, some money is better than no money. They don’t want you to leave, because then they get nothing.

The fact that you are the commodity means that you control the cost structure. And any broker that isn’t willing to be flexible with commission is going to lose out on business. So the very first thing that you should do tomorrow is call up your broker and get yourself a better deal.

Extending Your Shelf Life

New traders should all have one goal above all others — extending your shelf life. Why? Because, hopefully, one day you’re going to wake up at 3 o’clock in the morning and have your ah-ha moment when suddenly it all clicks. And it would be great if you still have the capital to trade and make it all worthwhile.

So the number one way to extend your shelf life is to lower your costs. And the best way to do that is to call your broker. But there are a couple other things you can do. I’ll write a full guide to extending your shelf life soon. However, if you want that information now along with a much more in-depth discussion of my experience with the prop vs. retail trading, you’ll want to watch Episode 5 of Pancakes and Pivots.

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By | 2018-01-07T17:11:07+00:00 November 13th, 2017|Pancakes and Pivots, Stories and Observations, Tips for New Traders|Comments Off on Comparing Proprietary vs. Retail Trading