Some prop firms profit from failure

The appeal of prop trading starts with a genuine problem around access to capital. 45% of people who don’t invest said they simply did not have enough money to do so. Talented traders lack enough capital to turn skill into returns. Proprietary firms are an alternative. They give capable traders the opportunity to manage substantially larger portfolios without first accumulating that capital themselves.

A prop trading firm supplies the capital, the trader supplies the strategy, and both sides share the upside. But along the way, much of the prop trading industry built a very different business around it.

For many aspiring traders, the first step toward a funded account is a paid evaluation or “challenge.” Pay a fee, trade a simulated portfolio under strict profit and drawdown rules, and earn access to a funded account if you pass. Fail, and the fee is gone. Want another shot? Buy another challenge.

The challenge cycle adds up

That cycle quickly adds up. In a study of more than 300,000 accounts across ten firms, run by prop technology provider FPFX Tech and reported by Finance Magnates, 14% of traders passed their challenge and obtained a funded account. The average account spent roughly $800 on challenges, typically across three attempts.

Only 7% of everyone who bought a challenge was ever paid.

That means 86% of traders do not pass, with money spent on expensive challenges and nothing to show for it.

A prop firm built around upfront evaluation fees does not need, or may not even want, traders to succeed to generate revenue. Every failed challenge generates another fee, and every repeat attempt can produce another on top of that. The trader enters the relationship trying to stop paying and start earning. The firm generates significant revenue before that ever happens.

Not every challenge-based prop firm is automatically predatory. Evaluations serve a legitimate purpose. Firms need some way to identify disciplined traders and filter out people taking reckless risks with large nominal portfolios.

The problem is when the evaluation itself becomes the product. A healthy prop business should have a strong economic reason to find good traders, develop them and keep them trading. When failure becomes lucrative, that alignment is weaker.

Pay after you pass

A new generation of prop firms is starting to attack that problem at the pricing level. LEVERAGED’s Turbo Trade model, for example, allows traders to begin a one-step evaluation for less than $9 rather than paying the full simulation fee upfront.

The larger activation fee becomes due only after the trader successfully completes the evaluation. The $8.88 initial platform fee is credited toward that activation cost. The activation fee varies by account size and is due within 30 days of passing.

That change has a big effect on incentives. A trader who fails has only put less than $9 at risk rather than hundreds of dollars. And if they were looking to proprietary trading to bridge a lack of capital, it does not actively profit off them in a predatory fashion.

This low cost entry exam has far more reason to identify traders capable of reaching the next stage, because its profit comes from the value proposition of prop trading that successful traders will generate revenue for both parties.

In other words, passing becomes more valuable to its business model. Simultaneously, proving trading savvy does not require making a large financial bet before placing the first simulated trade.

Education as a signal

Prop firms like LEVERAGED also have a concerted focus on pushing its model through a focus on education. Education offers the ability to increase the amount by which both sides benefit. It also means the firm is actively investing in its traders beyond upfront capital. It is a longer term view of success and is another signal a prop firm is serious about its trading model.

LEVERAGED combines its evaluations with daily webinars, courses, market reviews, coaching and ClayAI, its proprietary trading-signal tool. Trader development is a part of the prop firm’s job, not leaving traders alone to repeatedly purchase challenges until something works.

What business prop trading wants to be in

Prop trading still has a compelling purpose. A skilled trader with limited savings should not need a six-figure personal account to prove that they can manage one. Prop firms can bridge that gap and give retail traders access to substantially larger portfolios while enforcing professional risk limits. The industry must decide what business it actually wants to be in.

If the most reliable customer is the trader who fails, pays again and fails again, prop trading isn’t concerned with discovering talented traders, but is really turning a profit on those that fail. The firms that endure will need to prove that their economics work when traders succeed.

Pay-after-you-pass models are one way to start fixing that equation. They move the financial burden away from the beginning of the relationship and put more value on the outcome prop trading was supposed to deliver in the first place to find people who can actually trade.