What Is Proprietary Trading?

Proprietary trading is a helpful practice in finance, where corporations use their fund capital and engage in active trading to make potential capital gains. This practice is also referred to as prop trading. In this kind of trading, the firm trades financial instruments for its own benefit rather than for a client’s order. This offers flexibility to a firm in trading practices, and the return they make will remain with them. Thus, proprietary trading further allows financial establishments to use their expertise in evaluating and forecasting stock markets to invest properly and grow their value. This article covers the concept of what is proprietary trading by explaining aspects like proprietary trading meaning, benefits, how this type of trading works, and more.

How Does Proprietary Trading Work?

As per the proprietary trading definition, this type of trading involves financial instruments' bought and sold by financial companies, using their own finances. The goal is to achieve a certain degree of capital gains. To understand the answer to this question, let's analyse the following breakdown.  

• The companies set aside specific funds and create special teams of skilled traders who handle this type of trading.
• The traders are well-equipped and are further assisted by necessary trading applications, which facilitate the buying and selling of investments in real-time.
• All trading activities are undertaken after analysing trends in the market, specific events such as corporate announcements, and other relevant details.
• In most cases, the effectiveness of any form of proprietary trading depends on three elements: the skills of the specific traders engaged, the state of the market during the engagement, and the effectiveness of their trading risk management policies. 
• Since these trades are being done using the company's funds, all the gains earned from these trades are retained by the company, and losses are incurred by the company only.

Open Demat Account

Your first step to enter share market

Get Started

* By signing up you agree to our Terms and Conditions

Example of a Proprietary Trading Desk

As you understand, the proprietary trading desk refers to a situation when a firm trades with its own funds and attempts to make gains out of it. Let’s understand more in detail about how proprietary trading in India works with an example 

The proprietary trading desk employs specialist traders who monitor trading markets on a full-time basis. They have modern trading apps that assist them in identifying excellent trading opportunities. These traders consider both domestic as well as foreign markets.

The team uses various strategies, including market speculation using economic information, trend analysis, and quantitative analysis. They might buy and sell stocks within a single day or hold positions for several days, depending on their strategy.

The primary distinction from a standard type of trading is that in this case, these traders are spending their own company’s finances. Their sole goal is to perform transactions that will bring an increase in the company's earnings.

Why do Firms Engage in Proprietary Trading?

Financial institutions engage in proprietary trading to increase their chances of experiencing potential capital gains. This is because the primary competition is so intense that the regular service charges or commission revenues are insufficient for long-term sustainability. 

These institutions have some competitive advantages over ordinary investors. First, they have larger pools of funds and are better placed and faster at obtaining information that is sensitive to the market. On top of that, their tailored trading systems and professional experts aid effective market operations. 

Returns from proprietary trading usually tend to be higher than those earned using conventional investing methods. This potentially boosts the running of these financial firms and helps them meet their goals. Additionally, these institutions also hire experienced traders and provide them with the necessary tools. This helps in making a quick analysis of the market for identifying chances that can make potential gains. 

Benefits of Proprietary Trading

The following is the breakdown of several benefits of proprietary trading. 

• Market Making Functions: There are instances where these institutions become active market participants using proprietary trading in particular sectors and thus earn market-making status as part of their core functions. 
• Technological Infrastructure: With regard to proprietary trading, advanced technological systems and infrastructure are employed, thus presenting better operational capabilities.
• Strategic Development Framework: Organisations can employ specific analytical tools for designing and testing trading strategies before the actual investment begins.
• Operational Excellence: Advanced proprietary technology developed and owned by the institution gives it a significant edge in the execution of complex trading strategies and conducting high-frequency trading.
• Financial Performance: Depending on the organisation’s policy, successful proprietary trading operations carry out an effective utilisation of institutional capital, the profits of which directly belong to the company.
• Risk Management Authority: Currently, there exist risks associated with the volatility of the markets; institutions can execute transactions and ensure risk management protocols. 

Difference Between Hedge Fund vs. Prop Trading

The following is a breakdown of the main differences between hedge funds and prop trading.

Conclusion
Proprietary trading is one of the useful methods that financial institutions have adopted to enhance their wealth in the financial markets. These firms use their funds and expert traders to undertake tactical and technical analyses of the share market. While it carries certain risks, prop trading offers institutions the ability to make instant judgements without any limits and take all the potential gains. For those who want to understand how markets work, a few widely used share trading apps explain how these institutions conduct their strategies. As technology advances and effective traders combined with proper risk management may obtain positive results with prop trading.