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What a legit futures prop firm might look like
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What a legit futures prop firm might look like

  #1 (permalink)
North Carolina
 
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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 08:20 AM.
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  #2 (permalink)
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  #3 (permalink)
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I think you oversee a big chunk of compliance and regulatory reporting. There will be a cost to get capital on board and to increase activity.

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  #4 (permalink)
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If you want to make a disruptive model, a possibility would be to give a community of traders access to your co-location facilities and market data and let them develop the strategies for a profit sharing arrangement. I think, also, the profit objectives set should be targets and every trader evaluated individually. I mean if a trader hit 90% of the profit objective then that'd still be a good bet as long as all the other stats looked good. As for whether or not to shut a trader off or send back to sim, you would have a rolling series of statistics and a criteria based on that and the profits produced.

But you can turn what I developed into a sort of criteria for evaluating any prop firm... here's what it looks like

1. Does the firm offer up to 25k in at risk capital? You can score this on a scale. For example, 18k/25k = 72%. Reasonable. 2k/25 = 8% very questionable.
2. Does the firm offer/pass-thru its traders non retail advantages such as member commissions? This is valuable because it enables for deployment of strategies that might not be feasible on a retail platforms, i.e. like Tradestation or Ninja.
3. Does the firm offer co-location for automated strategies and data and tools to develop them?
4. Does the firm offer free access to quantitative developers, market research, etc?
5. Does the firm foster teamwork and trader development?
6. Does the firm track and provide in-depth statistics for their discretionary traders?
7. Are both the firm and trader's objective in alignment? This is demonstrated by a profit split near to 50/50 for most traders.
8. Does the firm have at least 3 traders producing significant returns of > 200k/year in post-split profits over the most recent 2 years? This is important because it demonstrates a viable business.

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  #5 (permalink)
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It seems like the prop world has pretty much shrunk and most are looking for high math types to develop algos. Do you see the prop world expanding in the feature and the algo game. How many prop firms are you aware of in the US?

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  #6 (permalink)
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I'm not an insider in the prop world. I haven't seen many opportunities but I'm not in Chicago. I just do the usual web search. There are some firms, of course but they aren't what one thinks of as the traditional prop firm. They require putting up some significant capital or maybe they have a natural business in some product or whatever and have traders because of that or they sell education/products like TST.

If TST can prove successful from shared model of risk/profits with traders (not just combine fees) then it is not difficult to imagine that someone can do a better job or at least offer a better gamble. But, I think for that to happen it would require a trader with an interest in that because there are a lot of other businesses outside of trading. I see some potential for disruption in the algo space, as well.

I hope TST and MES traders do well-- because I'm not aware of many other opportunities. Those are the ones I'm keeping an eye on for now.

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  #7 (permalink)
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tpredictor View Post

If TST can prove successful from shared model of risk/profits with traders (not just combine fees) then it is not difficult to imagine that someone can do a better job or at least offer a better gamble. But, I think for that to happen it would require a trader with an interest in that because there are a lot of other businesses outside of trading. I see some potential for disruption in the algo space, as well.

I hope TST and MES traders do well-- because I'm not aware of many other opportunities. Those are the ones I'm keeping an eye on for now.

I just checked out MES and they have joined with another company and will launch in February. The 50% split is a little high.

Speaking of disruption-- I would like to see an entirely different model that is more of a marketplace for equity providers and traders to link up. The equity provider can request a test period from 30-60 days and then have their own risk strategy.

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  #8 (permalink)
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MichaelFlowTrader View Post
I just checked out MES and they have joined with another company and will launch in February. The 50% split is a little high.

Speaking of disruption-- I would like to see an entirely different model that is more of a marketplace for equity providers and traders to link up. The equity provider can request a test period from 30-60 days and then have their own risk strategy.

That model already exists to some degree via Collective2 or Striker. The problem, at least with, C2 is that you can't bill per contract so from the system providers point of view then it makes it difficult to work out. For example, I had 2 top systems there over a 2 year period and closed them because it wasn't worth it. Striker looks more promising but haven't opened an account yet.

The other way to view a 50/50 split is that if a firm is truly offering an advantage and taking the risk then it's a fair split. Remember, the split isn't what's important it's the capital they give you. I'd rather trade with a 50/50 split with a larger amount of capital and no risk then trading with a higher split and taking the risk. Looked at another way, if a firm can't earn a 50% of my profits then they're probably not offering enough value and/or your interests may not be perfectly aligned. That would encourage the firm to make money other ways.

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  #9 (permalink)
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tpredictor View Post
That model already exists to some degree via Collective2 or Striker. The problem, at least with, C2 is that you can't bill per contract so from the system providers point of view then it makes it difficult to work out.

The other way to view a 50/50 split is that if a firm is truly offering an advantage and taking the risk then it's a fair split. Remember, the split isn't what's important it's the capital they give you. I'd rather trade with a 50/50 split with a larger amount of capital and no risk then trading with a higher split and taking the risk. Looked at another way, if a firm can't earn a 50% of my profits then they're probably not offering enough value and/or your interests may not be perfectly aligned. That would encourage the firm to make money other ways.

How would you compare Mes to TST and the value each one gives the trader. The splits are different and from MES's language they are directly trying to be a more streamlined TST or at least present themselves that way.

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  #10 (permalink)
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MES looks like it's taking a more vested interest in their traders. However, TST is a bit more transparent--though not as transparent as some of us want. TST has been around longer. We have to see what OneUp looks like but looks promising to me.

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