"Prop trading firms are victims of their own success": These firms have become too good at what they do, which might ultimately lead to their downfall.

The author of this article, Michael Berman, has over 20 years of professional fund management experience. He has worked as a prop trader in investment banks and high-net-worth individual firms, served as a hedge fund manager, and has dedicated the past 12 years to nurturing emerging traders.

The purpose of this article is not to review the various prop trading firms and their programs currently thriving in the OTC/futures markets. Instead, it aims to examine the pros and cons of this latest trend from the perspective of someone who has worked in various sectors of the trading industry.

The Real World - Hedge Fund Industry

The hedge fund industry consists of approximately 15,000 funds managing an estimated $5 trillion in assets, including Commodity Trading Advisors (CTAs) and managed futures managers. Statistics show that about 6% of funds close down each year, and looking at the long term, the industry's average annual return is around 8%.

Most crucial to our discussion is the fee structure, which is typically a 1% annual management fee and a 20% performance fee above the high-water mark.

I should add that managers' fees have been under pressure for years. From a regulatory standpoint, setting up a hedge fund or a regulated managed account is a daunting task, with high costs for establishing and maintaining compliance, including audit and administration expenses.

To have any chance of raising sufficient capital, fund managers usually need at least a 2-year track record, but ideally 5 years, along with an attractive risk-reward ratio and some prior corporate and educational background.

This is the formula required to have a reasonable amount of assets under management in the fund management world. However, nothing is guaranteed. Many talented traders who meet the above criteria still struggle to attract enough attention or interest to raise sufficient funds to operate a viable fund.

There are other forms of professional trading opportunities. These involve becoming a formal employee of a bank or prop trading firm, managing the company's own capital. These are typically highly sought-after positions with excellent compensation, usually around 10% of profits.

In short, getting the opportunity to trade large-scale capital is extremely difficult, very similar to becoming a professional athlete earning a substantial income. The competition is incredibly fierce, with only a tiny fraction making it to the top leagues.

Of course, we mainly see the success stories because that's what marketing salespeople focus on. They exploit the way our brains work, extrapolating the success of a few to what we perceive as a larger group.

Filling the Gap - Opportunities Brought by Prop Firms

The online trading boom that began in the 1990s with the rise of the internet accelerated in the 2000s with the growth of the OTC market. This growth has continued to the present day, giving birth to a massive industry.

I don't have space to describe the industry's development in detail, but one of the catalysts driving its growth was the amazing success of MetaQuotes (MT4 and MT5). They developed a technology suite that made it very easy and relatively cheap for companies with limited technical and industry experience to set up a brokerage.

The concept of prop firms for retail traders has existed for decades and is not new. It has always been there, offering a way to fill the gap for retail traders who aspire to become professional traders but lack capital and formal background.

These prop firms typically required you to be physically present, purchase their educational packages, and adhere to strict trading rules that made successful trading quite challenging. However, for those who could adapt to the rules and trade profitably, it was a legitimate opportunity.

However, the online retail trading market has witnessed massive growth in prop firms over the past few years.

These companies offer relatively easy challenges for a small fee, then give you the chance to trade quite large sums of money and keep 80% of the profits, all while working from home.

The temptation of potentially making big money and being your own boss for just a small upfront fee (the challenge fee) is simply too hard to resist for anyone interested in trading. Honestly, who wouldn't want to get rich easily?

Are Prop Firms a Scam?

No investor in the world would hand money to someone with no trading background to trade, let them keep 80-90% of the profits, and take all the risk themselves.

As mentioned earlier, for experienced traders, the industry standard is a profit share of about 10-20%. You should be cautious when someone offers something far beyond the norm.

Firstly, the money traders are trading isn't real capital. Companies providing prop capital charge fees, expecting to use these fees to pay out profit shares to the few who pass. Once there aren't enough new traders entering the system to cover the payouts to winners, the company becomes technically insolvent and unable to pay out.

These new-style prop trading firms have become victims of their own success. The demand for cheap access to large capital for trading is insatiable.

Everyone wants to make this kind of money, resulting in more and more prop firms popping up. These companies compete fiercely for clients, leading to increasingly high customer acquisition costs. Many newly opened companies simply lack the funds and expertise to handle the risks.

Simply put, many people rushed into this business opportunity, but many are amateurs who don't know what they're doing.

As a result, several companies have already gone bankrupt, and more and more companies are starting to employ dirty tactics. For example, they might use alleged violations of trading rules as an excuse to withhold profits. The problem is that these rules were never clearly communicated to traders, and worse, some companies even make up rules on the spot. In essence, they're doing everything they can to avoid paying out, trying to scam you.

Ultimately, these companies promising 80-90% profit shares simply can't sustain their business model for long. Most will eventually go bankrupt, and when that happens, clients' profit shares will vanish. This part of the industry is becoming increasingly unreliable and is playing with fire.

Final Thoughts

In trading terms, it's like this: The current wave of retail prop trading firms offering 80% profit shares is like a golden opportunity falling from the sky for those looking to trade more capital. The worst-case scenario is losing the small amount paid to participate in the challenge, similar to buying an option with limited risk.

If you're looking to trade more capital, I suggest sticking with well-known, initially successful companies. These firms should be in a better financial position and are less likely to default on payments.

Reference：Prop Trading Firms Have Become Victims of Their Own Success