Understanding Futures Funding Companies and Prop Firms
Hi, I'm John. Today, I'm going to talk about funding companies, particularly those involved in Futures, often referred to as Prop firms. My main focus will be on Topstep, as they are the largest and widely used.
Diverse Prop Trading Firms:
While there are numerous other Prop trading firms out there, I'll primarily cover Topstep. Keep in mind that each of these firms may have different rules, but the ultimate goal remains the same.
No Hate on Topstep:
Let me clarify that this article is not meant to criticize Topstep. It's here to help you understand what Futures funding companies are, and how you can make the most of them, whether you choose to use them or not. It's important to note that becoming a funded trader isn't as simple as it may sound.
Debunking the Myth:
So, we'll debunk the myths and reveal the truth about these funding companies. Afterward, you can decide if you're ready to trade with them, if you'd rather use your own funds, or even if you prefer to trade in a simulated account. Because that's what this is – even when you get funded.
Understanding the Strictness:
Let's delve into the specifics. Topstep, for instance, has strict rules. Their aim is to let the most profitable traders succeed, which, from a business perspective, is quite logical. However, if you're just starting out, you're unlikely to fall into the top 10% of profitable traders. In fact, you might not even be in the top 50%. You could be among the bottom 5%.
The Reality of Costs and Profitability
Entry Point Consideration:
If you find yourself in the bottom 5% and you're just starting to learn, I wouldn't recommend going for a Prop trading firm. Why? Because it's going to cost you a significant amount of money to learn how to trade. Let's take a look at the monthly pricing for these accounts.
These firms charge anywhere from $165 to $375 a month. Some even go as high as $600 per month. It might seem enticing at first. You think, "If I pay $300 a month, I'll get access to $150,000 or $100,000 to trade." But the catch is, they don't hand you that money. You'll be trading with a paper account or a demo account to prove your profitability.
Why Paper Trading?
From a business standpoint, this approach makes sense. They want to ensure that you can turn a profit before investing in you. If they just handed out money to everyone, their company would go bankrupt. The reality is that many of these funding companies stand to make more money if you fail. Let's be blunt about it – they profit when you don't succeed.
These firms typically have a profit-sharing model. For instance, Topstep offers 80% to traders, while they keep 20%. Others might give you 90%, keeping 10%. Regardless, the concept is the same. They generate substantial revenue from your monthly fees while you're in the process of paper trading to prove yourself.
No Upfront Risk:
From their perspective, there's zero risk involved upfront. You're trading with a paper account, and they're earning a minimum of $165 to $400 per month from your fees while you work to demonstrate your abilities. The longer it takes you to succeed, the more money they make.
Payouts Do Happen:
It's important to note that these firms do pay out when you meet their criteria. It's not a scam in that sense. However, their business model relies on the assumption that many will not succeed, and they will continue to collect those monthly fees. It's not a glamorous system, but it's the reality of how these firms operate.
Position Sizing and Loss Limits
Realities of Account Access:
If you're thinking you'll have immediate access to a $150,000 account, that's not the case. Let's break it down by considering profit targets, position size, and loss limits.
Position Size and Loss Limits:
On a $50,000 account, the daily loss limit is $1,000, and it's $2,000 for a $100,000 account. So, in essence, they're giving you a $1,000 daily loss limit for the $50,000 account. This means that if you hit your daily loss limit, you'll need to wait until the next month for your account to reset and have another shot. But here's the catch: you have to pay another minimum of $165 or, if they offer it, a reset fee, which is typically around $85 to $90. It's not a scam, but they've built various profit opportunities into their system.
How They Make Money:
These firms generate profits from monthly fees, as well as from reset fees. The more you blow your account, the more money they make because you'll be locked into paying monthly fees and likely wanting to get back into trading sooner. Human psychology plays a role here; we have the urge to make money quickly. You may decide to pay that reset fee to get back in the game. Different firms have various prices for resets and promotions, but the outcome is the same – if you blow your account, you end up paying more money.
Trading with No Leverage:
Even though you might be able to trade up to five contracts, there's no real leverage for the company because you're trading in a demo account. So, whether you trade five, ten, or fifty contracts, it poses no risk to the firm. You're given $1,000 or $2,000 in paper money to trade with.
The Challenges of Progressing in Funding Programs
Progressing Through Steps:
Let's delve into the progression through the steps of Topstep. In the initial stage, they set the daily loss limit. If you exceed this limit, you're in step one. Here are the rules:
- You need to meet your profit target.
- You must trade a minimum of five days.
The daily loss limit is somewhat lenient, typically ranging from $1,000 to $3,000. For instance, if you lose $900 one day and avoid hitting the trailing maximum drawdown, which can be $2,000 to $4,500, you're still in the game. If you do hit that trailing drawdown, you'll need to reset your account and try again. You remain locked into the program as that's where they profit the most, through monthly fees and resets.
Transition to Step Two:
Step two, however, is tougher. Not only must you avoid hitting your daily loss limit, but you also can't exceed your weekly loss limit. In this step, the daily and weekly loss limits are the same. So in step one, if you come close to your daily limit, it's manageable. For instance, losing $900 isn't a major setback as long as you don't hit the trailing maximum drawdown of $2,000.
Weekly Loss Limit Challenge:
Step two makes it challenging. Let's say you lose $800 one day. The next day, unlike step one, it doesn't reset. You only have $200 left before hitting your weekly loss limit. You then need to wait until the next week, which consumes time. You're left with a choice: do you risk blowing your account and paying a reset fee to get through the rest of the week, or do you wait until the next week, using up valuable time?
Making Tough Decisions:
Topstep provides enough flexibility for traders to make decisions, but it can be overwhelming, especially for new traders who may not fully understand the costs involved in trading multiple contracts. It's important to carefully consider your options and plan your strategy.
The Importance of a Repeatable Trading Process
Managing Contract Size:
If you're considering trading with five contracts and a $1,000 loss limit, let's walk through the calculations. We'll use a Futures calculator for the S&P 500 (ES). Each point in ES equals $50.
Example with ES Contracts:
Let's say you want to aim for five points with five contracts. This would result in a $1,250 potential loss, which exceeds your maximum loss limit. To stay within your limit, you might consider trading for just one point, which would be $250. However, new traders often struggle with discipline, stop-loss strategies, entry and exit plans, making it challenging to manage risk effectively.
Impact of Losing Money:
If you're losing money, especially on step two, your chances of breaking even decrease because you have fewer resources to work with. You're restricted by the weekly stop-loss limit, and this can make your journey more challenging.
If you're trading NASDAQ (NQ), the situation can be even more volatile. A single contract of NQ, targeting 10 points, would mean $200 in gains or losses. NASDAQ can be incredibly fast-paced, with rapid price movements. To reduce risk and manage your trades, consider trading in the micros, which are one-tenth the size. However, with micros, your gains and losses are smaller as well, making it essential to be aware of the potential limitations of your chosen contract size.
Trading Strategies and Contract Size Considerations
Importance of a Repeatable Process:
In trading, it's crucial to have a slow but repeatable process, just like in real life. Every successful trader follows a process consistently, day in and day out. This process includes determining the right position size, managing risk through stop losses and take profits, and adhering to a set strategy.
Diverse Trading Approaches:
Traders employ various approaches, such as technical indicators, price action analysis, or even just watching bid-ask data and order flow. There are many ways to profit in the markets, but regardless of your strategy, if you don't get your position sizing right, using two or three contracts with a daily or weekly loss limit can lead to trouble. There's a significant risk of blowing your account, even if you're in denial and think it won't happen to you.
Challenges with Stop Losses:
New traders often struggle with stop losses. Some don't use them, believing they won't take a loss. But the market can behave unexpectedly, and not having a well-defined exit strategy can lead to significant losses. Being disciplined as a new trader is challenging, especially if you've never experienced the pain of significant losses.
Understanding the Costs:
While participating in programs like this one may seem more appealing than losing $1,000 of your own money, it can become costly in the long run. Monthly fees add up, and after a few months, you might find it to be an expensive way to learn.
Cost-Effective Alternatives for Learning
Exploring Cost-Effective Alternatives:
If you're planning to use Topstep for five months, you'll end up paying $1,000. On the other hand, you can access a simulation account for free through platforms like Ninja Trader or Tradovate, which won't cost you a cent. You might argue that the risks aren't the same or that the lure of real money isn't there, as you tend to make profits in simulation but lose when using real capital.
The Importance of Treating Simulations Seriously:
However, it's crucial to approach your simulation account as if it were real money. Not taking it seriously can lead to trouble, especially when you eventually have real capital at stake. Your approach to simulation should mimic how you'd trade with real money, including setting stop losses and managing risk.
Cost-Effective Trading Options:
If you examine the rates, you'll find that Topstep and similar firms may not offer the most cost-effective options. Platforms like Ninja Trader or Tradovate allow you to trade micro contracts, such as the MES or MNQ. The intraday margin for one MES contract is $50, and you can open an account with as little as $400. For a micro NASDAQ contract, it costs $100.
Understanding Intraday Trading:
Keep in mind that the intraday margin rates mean you can only trade during the day and can't hold positions overnight, similar to the rules of many funding companies. If you're comfortable with intraday trading and need real market exposure, these platforms can provide a more hands-on learning experience compared to traditional simulation accounts or other funding programs.
Exploring Trading Platforms and Emphasizing Risk Management
Exploring Trading Platforms:
Let's compare the intraday margins for MES and MNQ contracts on different platforms. For MES on Tradovate, the intraday margin is $55, while MNQ costs $100. Ninja Trader offers a similar rate, with a slight advantage of $5 less for MES.
Consider Your Options:
Interestingly, Ninja Trader recently acquired Tradovate, so the dynamics in the industry may change. If you're looking to start trading, it might be advantageous to begin with one of these platforms. If you prefer using the same platforms that Topstep uses, you can open a Tradovate account and access a simulation account for free or trade with real money at a low cost.
Emphasizing Risk Management:
Regardless of the platform or funding program you choose, success in trading hinges on effective risk management. Just as you wouldn't succeed in real-life trading without it, the same principle applies here. You can set loss limits in Tradovate's security settings to manage your risk, and I can demonstrate how to do this in a demo article to help you avoid monthly fees.
If you're just starting out, using these platforms and their intraday margins can be much more cost-effective. Whether you're new to trading or experienced, it's essential to assess your readiness before committing to a Prop trading firm.