What Is "Prop" Trading?

"Wall Street is neither good nor bad... it just is.  How you choose to use it determines its nature." --Ev

Proprietary trading, also known as prop trading, is a type of trading activity that involves a financial firm, commercial bank or individual trader using its or his own capital and balance sheet to conduct transactions in the financial markets. The main goal of prop trading is to generate profits for the trader, rather than earning commissions or fees from clients. Prop trading can be risky, but also potentially rewarding, as the trader can capture the full gains from his trades.

Prop trading can involve various financial instruments, such as stocks, bonds, commodities, currencies, derivatives, or other securities. Prop traders can use different strategies and techniques to exploit market opportunities, such as arbitrage, statistical arbitrage, merger arbitrage, fundamental analysis, volatility arbitrage, technical analysis, or global macro trading. Some of these strategies are briefly explained below:

• Arbitrage: This is the practice of buying and selling the same or similar assets in different markets or platforms to take advantage of price differences and lock in a risk-free profit. For example, a prop trader might buy a stock on one exchange and sell it on another exchange where the price is higher, earning the difference as profit.
• Statistical arbitrage: This is a more complex form of arbitrage that involves using mathematical models and algorithms to identify and exploit pricing anomalies and inefficiencies in the market. For example, a prop trader might use historical data and statistical methods to find pairs of stocks that are highly correlated and trade them based on their deviations from the expected relationship.
• Merger arbitrage: This is a type of event-driven strategy that involves betting on the outcome of mergers and acquisitions. For example, a prop trader might buy the shares of a target company and sell the shares of an acquirer company when a merger is announced, expecting the price of the target to rise and the price of the acquirer to fall as the deal progresses.
• Fundamental analysis: This is a type of value-based strategy that involves analyzing the financial performance, competitive position, growth prospects, and intrinsic value of a company or an asset. For example, a prop trader might buy undervalued stocks and sell overvalued stocks based on their fundamental analysis and valuation models.
• Volatility arbitrage: This is a type of risk-based strategy that involves trading options or other derivatives based on the expected or implied volatility of the underlying asset. For example, a prop trader might buy or sell options when the implied volatility is significantly different from the historical or realized volatility of the asset, expecting the volatility to converge or diverge over time.
• Technical analysis: This is a type of trend-based strategy that involves using charts, indicators, patterns, and signals to identify and follow the direction and momentum of the market or an asset. For example, a prop trader might use moving averages, trend lines, support and resistance levels, and other technical tools to determine the entry and exit points for their trades.  This is the focus of TAOST trading.
• Global macro trading: This is a type of macroeconomic strategy that involves taking positions in various markets or assets based on the analysis of global economic and political events and trends. For example, a prop trader might buy or sell currencies, commodities, bonds, or stocks based on their views on interest rates, inflation, growth, trade, geopolitics, and other factors that affect the global economy.

Prop trading can be very lucrative, but also very challenging, as it requires a high level of skill, knowledge, discipline, and risk management. Prop traders need to constantly monitor market conditions, adapt to changing scenarios, and execute their trades efficiently and effectively. Prop trading can also create conflicts of interest between the firm and its clients, as the firm might use inside information, front-run orders, or trade against its clients' interests. Therefore, prop trading is subject to strict regulations and oversight by various authorities and agencies.

Prop trading is not for everyone, but for those who have the passion, talent, and resources, it can be an exciting and rewarding undertaking.