If you have the skills to trade Forex successfully, but do not have a lot of money to fund an account, one option is to work with a proprietary trading firm.
Prop firm trading lets you trade the firm's capital in exchange for a percentage of the profits. This may leave you wondering what happens if you lose. Will you be on the hook for those losses? That is the question we will address in detail in this guide.
How prop trading works
Before we can answer the question of what happens if you lose while trading with a prop firm, it helps to understand how prop firm trading works.
If you want to trade with a prop firm, you need to start by getting either an instant funding account or an evaluation account.
With an instant funding account, you pay a fee, and can start trading immediately. With an evaluation account, you first have to pass a challenge, and then you can begin trading with the firm. Here is how trading with a prop firm works:
- You sign an agreement with the prop firm company. This agreement specifies what will happen in the case of profits or losses. It will also tell you if you need to pay any fees.
- The company provides you with capital that you can use for trading.
- You place your trades on the prop firm account.
- If you are profitable, you receive a percentage of the profits as outlined in your agreement. The prop firm receives the remainder of the profits.
A quick note about live vs. demo trading
It is worth taking a moment to mention that the evaluation account is a demo account (more on that in the next section), but whether your next account is a live or demo account depends on the firm.
In this post, we are going to be focusing on proprietary trading firms that give traders live accounts that are funded with real money.
But there are also some prop firms that have traders trading demo funds forever, even after passing the challenge.
Obviously, with that type of prop firm, you cannot be liable for losses since real money is not involved. But there is another downside, which is that the prop firms are only profiting from challenge fees.
Prop firms that rely on traders taking challenges and failing them over and over may not be as financially viable as those that actually are involved in profiting alongside successful traders.
We suggest that you stick with prop firms that actually let you trade live funds for that reason. Now let's get back to discussing your financial liabilities.
Will you owe money if you lose during the challenge phase?
Now that you understand the basics of how prop firm trading works, let's discuss what happens if you lose. We will begin by talking about what to expect if you end up blowing through the funds in your evaluation account while attempting to pass the screening challenge.
When you are trading in an evaluation account, it is important to understand that it is a demo account, not a live account. The challenge is how the prop firm assesses whether to give you a live account.
Traders sometimes get confused about this because there often are fees for evaluation accounts and challenge attempts. But a fee is not the same thing as an investment in the market. You lose the fee regardless of what happens in the challenge.
You do not need to worry about being on the hook for other losses in your evaluation account. Since they are virtual funds, they are not real losses, either to the prop firm or to you. The fee is all you can lose.
You will not owe money if you lose while trying to pass a challenge with an evaluation account for a prop firm. You just pay a fee to attempt the challenge.
Will you owe money if you lose during live prop firm trading?
Let's say you pass an evaluation challenge, and you are granted a full account with a prop firm.
We have heard some people talk about being required to make a deposit to open a prop firm account, but we have never run into this at any major prop firm. The only "risk" is the fee you paid to complete the challenge for an evaluation account or to access an instant funding account, which is a foregone risk.
What about the money that the prop firm is providing for you to trade? In the majority of cases, you will not be responsible for covering those losses. That is the prop firm's risk, not yours.
Of course, you should carefully read over the agreement with the prop firm to make sure that the terms of that agreement stipulate this. There may be exceptions out there, and it is important to know what you are getting into. Whatever agreement you sign, you will be bound by its rules.
When you are trading with a prop firm, your losses are usually limited to the foregone risk of your challenge/account fee. You are generally not liable for the prop firm's lost funds. Check your agreement to confirm this.
How prop firms limit risk
You cannot just do whatever you want when you are trading with a prop firm. After the initial screening process where you pass the challenge, prop firms take a few additional steps to limit potential losses. These vary from firm to firm, but may include any of the following:
- Requiring traders to set stop losses, possibly within certain parameters.
- Employing limits for daily losses and overall drawdown.
- Setting limits for positions held overnight.
- Preventing traders from placing trades during news releases or other especially volatile times.
- Other rules and restrictions as the prop firm sees fit.
What happens if you break the rules your prop firm sets? Often, your account will close immediately, and you will be prohibited from returning to the platform. So, it is critical to be aware of the rules before you start trading.
Prop firms set rules and restrictions to enforce conservative, low-risk trading.
Quick tips for the best prop firm trading experience
To wrap up this post, here are a few recommendations to help you have a good experience when you become a prop firm trader.
- Research before choosing a firm. Not all prop firms are equal. While some prop firms are amazing to work with, quite a few are not financially stable. Make sure you are choosing a firm that has you trading on real, live accounts once they accept you. Avoid those that have you trading on "simulated" accounts. While you are researching the quality of prop firms, you can also check their agreements (see below).
- Read the agreement carefully. Make sure the agreement clearly states that you will not be responsible for the prop firm's funds, and will owe nothing if you lose them.
- Pick a firm with rules that are compatible with your method. You will have a tough time being profitable if the specific rules a firm uses to limit its risk make your strategy impossible to implement.
- Trade conservatively. Prop firms do not set unreasonable limits and restrictions; they simply set rules that are designed to prevent traders from engaging in high-risk trading. So, if you want to work with a firm, you should look for a conservative trading method to use. Frankly, that is the best approach to becoming a profitable Forex trader regardless. So, it is good advice whether or not you are going to become a prop firm trader.
Summary
You usually will not owe anything if you lose a prop firm's funds. When you trade with a prop firm, you are risking the fee you pay to attempt the challenge or open the account, while the firm risks the capital they have provided you to trade.
Whether you owe anything if you lose a prop firm's funds ultimately depends on your agreement with them. But in most cases, the answer is no, you do not owe anything if you lose a prop firm's funds.
