Exposing the Prop Firm Industry
Prop firms might be displeased with me for writing this article, but as someone who genuinely wants retail traders to succeed with full transparency and honesty, I feel compelled to expose the prop firm industry.
It's not just about the prop firm industry; it extends to the entire forex industry as a whole. Most people remain completely unaware of what's happening behind the scenes. I myself remained in the dark about this until several years into my trading career when I had a conversation with a forex broker owner.
In this article, we will delve into three main aspects:
- How prop firms used to make money.
- How prop firms make money today.
- Their secret weapon, known as a "Virtual Dealer Plugin."
I will demonstrate five different ways they utilize this tool to extract money from traders. You should take my insights seriously because we have assisted over 600 individuals in becoming funded prop traders. We even once operated our own prop firm and seriously considered buying our own brokerage but decided against it due to the information I will share in this article.
Let's start by examining how prop firms used to make money.
Historical Revenue Model of Prop Firms
Prop firms historically made money through a structured process. Individuals like you and me would deposit our hard-earned money into a bank or a fund to secure it. The bank, however, didn't let the money idle. Instead, they invested it in various avenues. Some of the funds were directed towards safe options like US Treasuries, while another portion might be invested in areas such as home loans. Additionally, some money would be allocated to higher-risk ventures like business loans.
Within the bank, there existed a division known as a proprietary trading desk or Prop trading. If you've ever watched the TV show Billions, you've seen this concept in action. The bank would set aside a specific sum, let's say $10 million, for this proprietary trading desk. Talented traders were then recruited to handle this money.
This arrangement was beneficial for everyone involved. Prop traders gained access to substantial capital; for instance, if there were 10 traders, each might have a million dollars to trade with. The bank profited because different traders used diverse strategies, generating yields for them. The traders were handsomely rewarded since they were proficient at making profits in the market.
Historically, this was how prop trading and prop firms operated.
However, in the last decade, we've witnessed the rise of online "Forex Prop Firms." Their approach to making money might surprise you. And if that doesn't, the next revelation certainly will.
Modern Revenue Model and Virtual Dealer Plugin
Today, prop firms, such as FTMO or the recent controversies surrounding "my forex funds," "true forex funds," or "the funded trader program," have adopted a different revenue model. They generate income primarily from people taking tests or challenges. Let's assume that each test costs $500.
These modern prop firms operate more like insurance companies. To draw a parallel, consider car insurance. Insurance companies have hundreds or thousands of customers paying, let's say, a $200 monthly premium. If, for instance, 100 people pay this premium, the insurance company accrues $20,000 in monthly income, understanding their numbers well.
Out of these 100 customers, a certain number will get into accidents and file claims, let's say totaling $10,000 per month. This results in a positive net income of $10,000 per month for the insurance company.
Prop firms work in a similar manner. They anticipate how many people will fail and how many will succeed. Suppose 100 individuals take $500 tests. This accumulates to $50,000 in revenue. However, the expense comes from those who become profitable traders.
Let's say that 2% of the 100 participants (or two individuals) become profitable traders and each makes a $5,000 withdrawal. This incurs a cost of $10,000. To sum it up, the prop firm earns $50,000 from test fees and spends $10,000 on withdrawals. Essentially, they redistribute the losses of the failing traders to pay the winning traders.
This is precisely what was exposed in the case of "my forex funds." Many people had suspicions about how this worked, but the truth is that the majority of times, firms like "FTMO," "my forex funds," or "true forex funds" do not execute the funded traders' orders in the market.
In fact, most traders are trading on a demo account when they receive a funded account. If they happen to profit on this demo account, they are simply paid from the funds of those who failed the challenge.
Unlike the historical model where prop firms and traders both benefited from profits, today's prop firms often lose money when traders make money. This creates a significant conflict of interest, as they may inadvertently want traders to fail. This is precisely why I'm writing this article – I want to help you succeed despite these odds.
However, it's important to note that this isn't always the case. There's a concept called A and B book brokering, which applies to prop firms as well as forex brokers. The key difference lies in what's called an "A book" and a "B book."
The Use of Virtual Dealer Plugin
One concerning aspect that many prop firms and B book brokers employ is the use of a "Virtual Dealer Plugin." When I first learned about what a virtual dealer plugin is, it made me feel uneasy. It was a stark revelation about the nature of the game we are involved in.
A virtual dealer plugin is a small piece of code or software that brokers can install in their brokerage system or price feed to manipulate the market. Let's delve into some of the actions this virtual dealer plugin can execute:
- Order Rejection: This means that when you place an order, it may not be accepted immediately, or it might be outright rejected and then filled at a less favorable price.
- Re-quoting: Similar to order rejection, re-quoting involves promising one price but executing the trade at a worse price, leaving you at a disadvantage.
- Pre-programmed Slippage: This is a red flag that can easily indicate the use of a virtual dealer plugin. Slippage occurs when you intend to exit a trade at a specific price but end up getting out at a different, less favorable price. It can work for or against you, but if you consistently experience negative slippage, it's a cause for concern.
- Order Delay: This involves delaying the execution of your order, causing latency and potentially leading to less favorable entry points.
- Spread Widening: Here, the broker increases the spread (the difference between the bid and ask price) as your trade approaches your stop loss, which can trigger your stop loss prematurely and benefit the broker.
You might wonder why brokers engage in such untransparent and manipulative practices. The answer lies in their business model. If they are operating as B book brokers and taking the opposite side of your trades, it is in their best interest for you to lose because your losses become their profits.
It's worth noting that in regulated environments like the United States, such practices are less common, but they still exist. I've even seen prop firms in the US using virtual dealer plugins.
Now, you might be concerned about profitable traders. If a trader consistently makes money, it can be a financial burden for the broker or prop firm, especially if they are A booking traders. However, in most cases, brokers may wait until a trader achieves multiple payouts (which is rare) before considering A booking them. It's a way to minimize their risk.
Summing it up, a virtual dealer plugin is a tool that can tilt the odds against traders. However, understanding this is the first step. You have options: seek more favorable brokers, opt for prop firms with stronger regulation, or simply accept that this is the nature of the game.
In every industry, there are shady practices, but our goal is to navigate them wisely and become better traders.
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