Welcome Traders: Prepare to enter the world of Prop Trading where the rewards are high, the risks are low, and the land of Milk and Profits lies before you. [OR: there is a Red Sea of Assets beneath your feet] For the Holy Grail of Funding you must remember the 10 Commandments of Prop Trading. We will enlighten your trading journey with divine wisdom (and a dash of humor) to help you navigate the waters of funded trading and keep your head cool and your position in profit even in the eye of a market storm.
Table Of Contents
Grab your tablets (not the stone ones) and let us part the Red Sea of Prop Trading Rules:
*Please bear in mind the “10 Commandment” format is to keep the rules' explanations fresh and memorable, and no offense is intended!
Traders seeking leverage through funded trading need to be able to demonstrate their profit potential. What better way than with a Minimum Profit Rule? Traders will need to achieve a minimum profit threshold to be brought on board as a Funded Trader, or to pass to the next stage of an evaluation of “Challenge.” The profit target in question (and the time you must meet it) will vary from firm to firm. Moreover, the amount will be a percentage of your starting account size. The best way is to visualize this rule in practice with three (imaginary) traders: Mark, Maria, and Maalin.
The Minimum Profit Rule comes in different forms, but the reason remains the same. The rule is designed to assess traders’ ability to recognize profit opportunities, capitalize on market conditions, and grow their accounts accordingly. These will become the Funded Traders that will earn the highest not only for themselves but for the prop trading firm.
Prop trading firms need to assess your ability not only to reap rewards – but also to manage risk. There would be no point in their funding you with company capital for short-term gain only to have you lose it all in one big trade. Therefore, risk management is as critical as profit generation. Prop firms have a “Drawdown Rule” which is in two parts:
The best way to understand the above is to break these down and visualize how a trader might experience this rule in practice:
Example 1: Maximum Daily Drawdown
For this exercise in imagination let us once again borrow Maria and Maalid (sorry Mark, you can jump in again later!) Say you have a prop firm with a Maximum Daily Drawdown limit of 3% for their traders. In other words, the rule is that a trader's account balance cannot dip below 3% from its highest point in a single trading day. Maria kicks off with an account balance of $100,000. Throughout the day, she opens several trades and takes some hits. At one point, Maria’s account balance reaches a high of $110,000. However, market volatility rocks the account boat and Maria has a blip of several losing trades, resulting in a decrease in the account balance.
Should Maria’s account drop to $106,000 this will be a 4% decline from the highest point of $110,000. We can all do the math, 4% Is higher than 3% and unfortunately for Maria, she has just breached the Maximum Daily Drawdown Rule. The consequences will depend on the prop firm: there could be a temporary suspension or other penalties imposed by the prop trading firm. In Maria’s case, she is temporarily suspended. She is on the bench for now!
Example 2: Maximum Overall Drawdown
Now let us add some comparison color to this rule and explain it further. Consider a prop trading firm that sets a Maximum Overall Drawdown limit of 10% for their traders. This means that over the course of a trading period, a trader's account balance cannot decrease by more than 10% from its peak value.
Maalid chooses this firm and starts with an initial balance of $50,000. Over time, Maalid has his share of hits and losses until he hits a high of $60,000. Alas for Maalin, he then has a downturn of several losses. If his account balance drops to $54,000, he will have lost 10% of his all-time $60,000 peak and thus violate the Maximum Overall Drawdown Rule. In Maalid’s case, his prop firm decides to evaluate his performance to ascertain what circumstances led to the breach. He then has a meeting with the prop firm’s risk team and his account is temporarily restricted – his buying power is reduced, and he has stricter risk controls. Maalid is also given additional training: showing how sometimes the accidental violation of a rule can be a valuable learning experience. What does not fail you makes you stronger!
Do note that the specific Maximum Daily Drawdown and Maximum Overall Drawdown limits vary between prop trading firms. Do read your T&Cs and make sure you understand the trading guidelines set by the firm you choose before starting your challenge.
Once again, prop firms have a wide range when it comes to the financial assets on the trading table. Welcome to the Rule of No Trading Restricted Assets. Some proprietary firms will specialize in a specific asset class such as futures or equities – others might have a broader range including currencies, options, or commodities. Traders, therefore, will be banned from trading in assets or classes restricted by the firm. The reason could be the volatility or liquidity of a particular area as this could result in excessive risk-taking and therefore potential losses. This rule is another example of the diverse nature of prop trading: firms will differ according to appetite for risk and core trading approach and traders should choose one that suits their professional needs.
This rule relates to weekend holding and overnight positions. Not all prop firms will let you keep your trades open outside of market hours. You may find your proprietary trading firm has an Overnight Holding Rule or a Weekend Holding Rule.
Overnight Holding Rule: Most prop firms now allow funded traders to keep their positions overnight, but you may find yourself in a position where you are trading with a firm that has an Overnight Holding Rule. In this case, you simply must ensure all trades are closed before the end of the market session. Weekend Holding Rule: Some prop firms state that traders are not allowed to maintain open positions beyond the market close on Friday, i.e., all positions must be closed before the weekend begins.
In other words, the News Trading Rule. This rule stipulates that traders adhere to the prop firm’s guidelines on trading around news events. This could mean that they cannot trade immediately before or after major news events or reduce their positions to minimize volatility. The news trading restriction is increasingly rare among prop firms, many of which now permit traders to keep their positions open even during periods of high (or low) volatility sparked by news releases. Nonetheless, if your trading style or appetite for risk is better suited to a firm that does not accommodate news trading, you may find yourself a good match for their other guidelines and risk management policies.
Day traders looking to pass a Funded Challenge need to keep a few potential restrictions in mind. Depending on the prop firm in question, there could be limitations or even bans on certain strategies. Traders may be prohibited from:
As with all the 10 Commandments of Prop Trading, this rule is not a hard and fast definition across all prop firms. Some will be stricter on one rule and lenient on others. The reason that prop firms impose the restrictions and regulations they do is to qualify traders for the company capital. Therefore, it is wise to do your research and choose a Challenge whose rules complement your natural trading strategy, as this will increase not only your chances of success during the evaluation but your long-term future with the company.
In other words, the “Loss Recovery Rule.” When it comes to prop trading, people often assume that profits are shared and that any and all losses are assumed by the firm. While this is true to an extent, if a trader wants to be successful in a Prop Challenge and scale up through the ranks as a funded trader, they need to demonstrate not only their ability to gain profits but also to recover losses.
Prop trading rules are designed to assess traders’ risk management techniques and trading discipline. Losses are a natural and often unavoidable part of trading, but traders need to make demonstrable efforts to recoup losses and restore their accounts to a profitable state. This could be achieved through tweaking a trading strategy or approach, adjusting take profit and stop loss orders, and reducing position sizes.
This rule may seem like a tall order but remember that prop firms want you to succeed – and there is nearly always help at hand. Many prop firms have an on-call risk management team, training resources, or even an appointed account manager dedicated to helping you avoid these situations.
As prop trading rules go, this one is a blanket rule that covers multiple protocols in one. The small print of the regulations in question will depend on the firm and its legal jurisdiction. Each prop firm will have its own trading compliance rules, depending on the regulatory and financial body with which it operates. Traders may be required to follow a Code of Ethics to keep in line with the professional behavior and integrity of the prop firm.
Traders are expected to report any compliance violations or suspicious activities to the prop firm. Moreover, prop trading firms integrate strict regulations into their platforms to protect not only client funds but also identity. The “Know Your Customer” (KYC) protocol is designed to safeguard clients against identity theft and suspicious financial activity.
Better known as the “Trading Frequency Rule,” this regulation ensures that traders avoid strategies or approaches that disrupt market integrity or violate guidelines. “In all aspects of life, balance is key.” Ziggy Marley may not have been talking about day trading specifically, but his advice also rings true here. During a prop trading challenge, traders need to weigh up many factors, including market liquidity, and the assets in question, alongside the risk management guidelines and regulations of the prop firm. Practices including excessive trading, or frequently canceling orders, are considered a breach of this rule.
Once again, let us take a working example to visualize this rule in practice. Welcome back, Mark!
Mark has just signed up for a prop trading challenge with a Trading Frequency Rule. According to their guidelines, traders must be balanced in their trading. Moreover, they need to abstain from excessive or disruptive trading.
Unfortunately, while Mark is an excellent trader sometimes his ambition can get the better of him. In his impatience to drive up his profits, he neglected to maintain the balance. Mark opens an inordinately high number of trades in short timeframes, entering and exiting positions within seconds and ignoring the potential impact on the market. Mark’s behavior begins to disrupt the normal functioning of the market, with the sudden flow of orders and cancellations affecting liquidity. Furthermore, other traders begin to find themselves adversely affected: Mark’s high-frequency trading is making it difficult for other market participants to execute their own trades.
Mark’s unusual trading activity does not go unnoticed. The prop firm’s monitoring systems identify that the trades in question have been detrimental to market fairness and efficiency. The prop firm has no choice but to take disciplinary action against Mark. Not only has he violated the Trading Frequency Rule, but his action is negatively impacting his fellow traders. The sanctions that follow will depend on the company, but prop firm measures can include warnings, restrictions, or in some cases even termination from the program. Luckily for Mark, his funded trading platform chooses to give him an official warning, and his account is temporarily restricted while he trades under increased observation.
The Lot Size Rule will alternate from firm to firm. Prop trading typically sets out minimum or maximum lot sizes within which traders must operate. Lot sizes refer to the positions possible: the quantity of an asset or security that can be bought or sold in a single trade. The Lot Size Rule is put in place by the prop firm to ensure profit consistency alongside minimizing the risk of losses. A minimum lot size encourages traders to be active (but not excessive,) while a maximum cap prevents traders from exposing themselves to too much risk.
Like many of the prop trading rules, the lot size positions are designed to assess – and train – traders to effectively manage risk, maintain profitable positions, and keep a level playing field among competitors. Success in a prop trading challenge hinges on traders’ understanding of lot size rules, so make sure you review these carefully before entering.
Welcome to the “Consistency Rule.” Not all prop firms have this requirement in place, but it is useful to understand this rule. The clue is in the wording: traders must be consistent. Prop firms require not only that potentially funded traders can make profits – but that they can make steady profits. The key is not quantity but consistency: because it is this which demonstrates long-term reliability.
Prop firms are more likely to trust a trader who can keep a steady stream of consistent profits over a longer period or one who has a one-off windfall – because it is the former trader who will generate more for the firm over time. Prop trading is a two-way street: the company will give you the capital, but you must show that you can be entrusted to use it to its maximum potential.
In conclusion, these 10+1 Commandments of Prop Trading are the rules that will guide traders to success in their Challenge. By carefully reviewing these tenets, traders can maneuver the often confusing and intricate trading rules embedded in funded challenges. Remember that these rules are designed to hone good trading practices: highlighting the importance of risk management, effective strategies, and regulatory compliance. Not all funded traders will be successful the first time around, but the trading practice and market experience serve as an invaluable foundation upon which future success is forged.
Note that these prop trading rules are not rocks to trip you up but stepping stones to financial freedom. Trade with discipline, strive for excellence and respect the prop firm guidelines, and you can unlock your true potential with the right funding platform.
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