Are Prop Firms “RIsky”?
Over the last few years, if you’ve been keeping an ear to the ground in the online retail trading space, you’ll have seen plenty of prop firms come and go. This has, rightfully so, created the narrative that prop firms are risky and should be avoided by traders. On the other hand, there are traders that don’t believe prop firms have any risk, and all sensible traders should be looking at trading with a prop firm.
The truth lies somewhere in the middle.
Prop firms are risky, if you use a non-reputable prop firm.
Prop firms that give traders demo capital mirror the business models of pyramid schemes, making those a much higher risk. To limit these risks, work with a reputable, established prop firm that funds traders with real money.
In this article, we are going to look at whether prop firms are risky, how to avoid these risks and what to look for. So, let’s get into it…
Are Prop Firms Risky?
Online prop firms are not risky innately – much like any industry, it depends on the firm you work with. In the same way, forex brokers are not risky, but working with an unregulated broker will present a greater level of risk. The online prop firm industry is currently unregulated, meaning firms are popping up constantly with more aggressive business models and no thought to compliance and regulation. It’s still an open topic as to who will actually regulate the online prop firm space… Will it be the financial regulators? Or perhaps the gaming regulators? There are many options, but whatever the decision may be, many prop firms will be out of business when the regulators come knocking.
Regardless of the risk, there’s no doubt that online prop firms are a great way for traders to skyrocket their capital under management and start making real money from their trading skills – rather than a few dollars here and there. This is why most traders are happy to ignore the risks that non-reputable prop firms bring.
The Dangers Of Forex Prop Firms
There are multiple risks and dangers of prop firms that you should be aware of, so you can look out for the signs. It’s worth noting that the signs are not always clear – sometimes firms will pack up shop overnight – but you can usually see the warning signs beforehand!
1. Being Manipulated During Challenges/Funded Accounts
Later in this article, we are going to discuss the two different business models that prop firms work with. There are prop firms that operate with a ‘demo funding’ model, or a ‘real money funding’ model. Demo funding prop firms only make money from traders failing their prop firm challenges. They will lose money on traders getting funded and taking withdrawals from the prop firm. Therefore, to increase profitability, they will often manipulate prices and spreads during a prop firm trading challenge to ensure more traders are losing their challenges. This is something you need to be aware of, as many traders get caught out with large spreads or spikes in price to take out their stop losses – in the same fashion as B-Book brokers do.
2. Being Denied Payouts Due To Rules
Less reputable prop firms will usually have complicated rules that are unclear for traders. This is done intentionally, so the prop firms can hold payment and deny withdrawals when required. This is, again, typically done by the prop firms that offer demo capital. It’s worth fully understanding all of the trading rules before taking a prop firm challenge, so you can model your trading plan accordingly. You can read Lux Trading Firm’s Trading Rules here.
3. Slow/Held Withdrawals
When any company, prop firms included, starts slowing down on withdrawals, this is a cause for concern. We’ve seen it time and time again, firms taking 5x longer to process withdrawals for traders when they run into financial trouble. When the withdrawals are taking longer, the negative reviews flood in. Once the negative reviews are online, the prop firms get fewer sign-ups and they crumble overnight.
This is very typical in the ‘Ponzi scheme’ style prop firms that fund traders with demo capital, as these firms rely on constantly having new traders signing up to drive their revenue.
Is Prop Firm Trading Legal?
Prop firms have been legal for many years – since their inception. Online prop firms are also completely legal, although currently not regulated. There has been much speculation over the last year around regulation and when this industry may be subjective to regulation. This will be a massive benefit for all traders, as many of the less reputable prop firms will be non-compliant and pack up shop – cleaning up the industry for the rest of us! This will ultimately give traders a safer and more profitable environment to operate within, without the constant fear of being scammed.
At Lux Trading Firm, we’re expecting regulation to come sooner rather than later, so we’ve built our business around transparency, compliance, and real money funding – mirroring that of a brick and mortar prop firm, rather than a Ponzi scheme.
How To Select A Reputable Prop Firm To Work With
Traders must consider conducting due diligence on a prop firm before committing to obtaining a funded trading account from them. There are a few critical factors to consider…
1. Business Model
As a crucial first step, take a look at the business model used by the prop firm. There are two types of business models in the industry:
- Real money funding
- Demo funding
At Lux Trading Firm, we operate in the real money funding side of the industry and give all our DIY traders and our Elite Traders Club ones real capital to trade with. This means that we want our traders to make money and succeed – we make profits when they make profits. When the prop firm’s values and objectives align perfectly with those of the trader, the trader can be sure they’re being given the best trading environment and best support to succeed!
The second business model is the demo funding model – adopted by the majority of the online prop firm industry. In short, these firms only make money from traders failing their prop firm funding challenges, and the firm loses money on profitable traders taking withdrawals.
This means two things:
- The trader and prop firm’s goals are not aligned. You want to be profitable, the prop firm needs you to fail.
- The prop firm has a Ponzi scheme style model – paying out profitable traders with the money made from new traders failing their challenges. If the churn of new traders stops, the prop firm will go bust overnight…
These are points that you should be really considering when choosing the right prop firm to work with. Just because they have 15,000 reviews on Trustpilot, doesn’t mean they won’t be going bust tomorrow!
Reviews are another key factor to consider when working with a prop firm. If the reviews are not positive, or you’re seeing numerous negative reviews left on third-party sites – this is a red flag that must be taken seriously. There is rarely smoke without fire when it comes to reviews. It’s worth checking third-party sites like Trustpilot, to establish the sentiment of traders. For example, Lux Trading Firm has a 4.4 star rating over roughly 500 reviews on Trustpilot. This is what you’re looking for – these kinds of stats cannot be faked by a new prop firm!
3. Time In The Industry
The third factor to consider is the length of time this prop firm has been in the industry. The reason for this is, typically speaking, brand-new prop firms will not have the operational maturity yet to see whether they will stand the test of time. This doesn’t mean that they won’t be a successful prop firm, but you would rather not be the guinea pig! Work with prop firms that have an established track record in the industry over many years – like Lux Trading Firm!
In Summary – Are Forex Prop Firms Risky?
In conclusion, prop firms are risky if you are using a non-reputable one. If you trade with a reputable real money prop firm, your risk is drastically reduced. Demo funding prop firms hold the most risk for traders, as they rely on a new influx of traders signing up to drive revenues and pay out profit traders – which is very reminiscent of a Ponzi scheme. Real money prop firms do not require new traders to stay afloat – which is why they stay afloat for the long term!
Are you looking to get funded? Work with Lux Trading Firm today!