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What a legit futures prop firm might look like

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North Carolina
Trading Experience: Beginner
Platform: NinjaTrader, Tradestation
Favorite Futures: es
Posts: 644 since Nov 2011

What a legit futures prop firm might look like

I wanted to try to come up with some sort of design of what a legit futures prop firm might look like and be structured as. The root problem with any prop is that most traders can't trade both consistently enough and profitably enough to make it work and the futures contracts are so large that it makes any sort of experimentation very expensive. But, even given that limitation that such a structure might not be profitable, I wanted to try to lay out some broad boundaries of what would be reasonable.

1. Firm capital

How much risk capital would be realistic? How much would be too much? There is a lot of evidence that around 25k in RISK capital is the minimally sufficient level to trade professionally. Most traders are willing to take a 25% to 30% DD and this would represent a 100k model account. Beyond that, it is the level to meet the PDT for stocks and the level that many prop firms require to join. This is also about the right number for 12x a max daily risk of 2k per day. We can thus phrase it thus that a realistic funding opportunity would probably offer the trader up to 25k in risk capital or some significant portion thereof. Anywhere from 12k to 25k would be realistic.

2. Try out parameters and length of evaluation

10 days simply isn't long enough to evaluate anything. 30 days is better but probably too short. A realistic try out period must be short enough such that it is relevant and long enough to at least capture some of the variability of the market. It would also need to short enough not to detract the majority of participants. It seems that around 3 months would be the minimum realistic evaluation time for a trader/strategy.

As far as rules, you don't want to make too many rules because you want to be able to find whatever is working. But, the basic rules of a 1.5k to 2k daily loss limit and no holds when market is closed makes sense. In addition to those rules, you'd want to see relatively frequent trading and reasonable distribution of profits across those trades. There's really no reason to require traders be flat before a news report because if that's a very a risky thing to do then we'd expect for it to weed the traders out. On the other hand, there might be a quantitative trader who has developed a way to profit from reports. Realistically, you may have to leave some discretion open in what traders get funded simply because it is not possible to create a rule for every possible scenario.

As far as the best metric for determining the best strategies, the total profits to the maximum drawdown is probably the best metric. 4x cumulative profits to maximum drawdown would be a tough but reasonable measure. You also need to use a realistic limit order fill engine and/or require a minimum avg profit per trade.

But, this is what I think it would look like: Max DD < 18k, Return at least 4x MAX DD and at least > 18k, 90 Days, Daily Loss Limit < 1.5k, No Holds When Market Closed. I do think these metrics would be really hard to hit for most traders but might be possible.

3. Firm advantages

Because it is not easy to profitable, you'd expect the firm to have member rates and pass those on to the traders. This would give the traders an edge over retail traders and one more incentive to stay with the firm. You might also have at least some co-location facilities and possible quants/programmers to help automate strategies.

Another alternative to a high technology operation might be to force the traders to hedge against each other. This would double the at risk capital available without requiring any additional capital. In the simplest example, a trader gets long the S&P 500 in anticipation of a trend day. The other trade would be required to scalp to the short side. Randomly requiring the trader to trade from opposite sides of the market might also reveal the best traders. You could also require the traders to simply trade opposite to some longer term net overall exposure.

At any rate, you want to help the traders to succeed. So you're going to want to be able to create a real sense of a trading floor and also invest in quants/programmers that can help your traders.

4. Skin in the game / at risk capital

If you believe that skin in the game would be helpful and we already determined that up to 25k of risk capital should be enough for most to get started then we could calculate some percentage of that as skin in the game. Realistically, most traders from western nations could come up with 2k to 3k of risk capital. This could represent 10% to 15% risk on the traders behalf. I.e. a trader puts up 3k and gets 18k of total risk. Starting profit split of 50/50 to 60/40 would be reasonable as you, the trader, are taking 10% of the risk.

Last edited by tpredictor; January 8th, 2017 at 09:20 AM.
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