What Is a Prop Firm and How Does It Work?
A proprietary trading firm (prop firm) is a company that trades financial instruments using its own capital, not client funds. The purpose is simple: generate profits for the firm itself. Instead of managing your money, a prop firm backs skilled traders with the firm’s capital and then shares the profits.
Modern retail-oriented prop firms add a unique twist. Before accessing firm capital, traders usually complete an evaluation called a challenge. If they pass under strict risk rules, they are granted a funded account which is often simulated to mirror live markets. Other firms offer direct funding, which skips the evaluation but usually involves higher upfront costs or stricter payout rules.
In both models, the firm provides market access, sets clear rules, and splits profits with the trader, commonly offering 80 to 90 percent to the trader after milestones.
Definition of Proprietary Trading
Proprietary trading means a firm uses its own funds to trade assets such as equities, futures, forex, and derivatives. The goal is to earn returns directly for the company. Unlike brokers or advisors, prop firms do not manage client deposits in these setups. Instead, they allocate internal capital to traders who prove consistent and skilled under firm-defined rules.
Key characteristics include:
- Firm capital is allocated to accounts for trading.
- Risk management rules govern trading activity, with limits on maximum daily loss and overall drawdowns.
- Profits are shared between the firm and trader, typically with the trader receiving the majority once scaling goals are met.
How Prop Trading Firms Operate
Retail-focused prop firms usually operate in one of two ways. First, the evaluation model where traders pay a challenge fee, trade under strict guidelines, and aim to pass without breaching risk limits. Second, the direct funding model where traders can access a funded account immediately in exchange for higher activation costs and often more restrictive payout conditions.
Operationally, most firms provide simulated accounts that replicate live market conditions, including spreads and commissions. These accounts help the firm monitor trader performance and risk management. Firms like FTMO clearly state that challenges and funded accounts are run in demo environments that closely mirror real pricing and fee structures.
Futures-oriented prop firms such as Topstep rely on subscription evaluations called Trading Combines. Once funded, traders follow profit-sharing rules such as keeping 100 percent of the first $10,000 earned and then 90 percent thereafter.
Types of Prop Trading Models (Challenge vs. Direct Funding)
Challenge Model: In this model, traders pay an entry fee and attempt to hit specific profit targets without breaking daily or overall loss rules. Many firms also allow retakes or resets for additional fees. Passing earns the trader a funded account with profit-sharing privileges.
Direct Funding Model: Traders gain immediate access to a funded account, often for a higher upfront fee. This comes with stricter rules or capped payouts in the early stages. Some firms gradually increase profit split percentages as traders hit milestones.
Core Revenue Streams for Prop Trading Firms
Challenge Fees
Challenge fees are one of the biggest revenue sources for prop firms. For example, FTMO charges a one-time fee that scales with account size and reimburses the fee once the trader receives their first payout. By contrast, Topstep uses a subscription model that charges monthly fees depending on account size.
Since many traders fail their first attempt, firms benefit significantly from fees tied to repeated challenges and resets.
Evaluation Retakes and Monthly Subscriptions
Some firms monetize traders through recurring monthly subscriptions. Others charge for retakes when a trader fails an evaluation. Either way, this ensures consistent revenue for the firm while giving traders repeated opportunities to qualify for funding.
Profit Split Commissions
Once funded, the trader and firm share profits. FTMO generally offers an 80 percent split to the trader, which can increase to 90 percent through scaling. Futures firms like Topstep allow traders to keep all profits up to a threshold, such as the first $10,000, and then shift to a 90/10 structure in favor of the trader.
Spreads, Commissions, and Broker Partnerships
Many firms also earn from spreads and commissions charged to trades, even in simulated accounts. By replicating real transaction costs, the firm creates additional profit streams while ensuring that trader performance accounts for realistic market fees.
Retention of Trader Losses
In many retail setups, traders operate in simulated environments. If a trader loses, the firm does not take a real market loss. Instead, the firm retains the trader’s evaluation fees and avoids direct exposure.
Upsells and Add-On Services
Many prop firms also sell educational courses, trading tools, or mentorship programs. These offerings provide another income stream while making the firm appear more valuable to new traders.
How Much Do Prop Firms Really Make?
Average Revenue Per Trader
The revenue per trader depends on the model. Firms using subscription evaluations earn ongoing monthly income, while one-time challenge models depend more heavily on high volumes of traders attempting to pass.
Funding Pass Rates and Profit Impact
Most firms have pass rates in the single digits. For example, Topstep disclosed that in 2024, about 12 percent of evaluations were completed successfully and fewer than 1 percent of traders advanced to live funded accounts. This highlights why evaluation fees are such a critical part of the business model.
Examples of Revenue Potential
If a firm has 10,000 active subscribers paying $99 per month for evaluations, it can generate nearly $1 million per month. A challenge-based firm selling 10,000 evaluations at an average of $200 each can also generate millions in revenue, especially if many traders need retakes.
Risks and Hidden Costs in Prop Trading
Strict Evaluation Rules
Prop firms impose detailed trading rules including daily loss limits, maximum drawdowns, and profit targets. Even profitable traders can fail if they break a single rule.
Scaling Limits
Some firms only allow gradual increases in account size and profit splits. For example, scaling plans may require hitting consistent profit milestones before traders can increase capital or reach the top payout tiers.
Withdrawal Restrictions
Withdrawals are often subject to minimum profit thresholds, time-based rules, or maximum caps. Some firms pay traders weekly, while others only allow payouts once per month.
Psychological Pressure
The pressure of evaluations, strict rules, and financial stakes can cause stress, leading traders to overtrade or break rules. Successful traders must learn to manage these emotions as much as they manage market risk.
Are Prop Trading Firms Profitable Businesses?
Profit Margins in the Prop Industry
Prop firms often have high profit margins thanks to recurring fees, digital platforms, and low overhead costs. The model is especially profitable when a large number of traders attempt evaluations without passing.
Scalability and Costs
Since prop firms mostly operate online, they can scale like software companies with minimal additional costs. The biggest expenses are payment processing, technology infrastructure, and customer support.
Business Risks
Prop firms do face risks. Regulatory agencies may investigate certain practices, as seen with recent enforcement cases. Platform providers can also disrupt operations by changing rules or cutting access. Reputational risk is another factor since delays in payouts or overly strict rules can cause backlash.
How to Choose the Right Prop Firm
When evaluating a prop firm, focus on several factors:
- Profit split percentages and payout conditions
- Maximum drawdown rules and daily loss limits
- Frequency of payouts and minimum withdrawal amounts
- Supported markets and trading platforms
- Type of fee structure, whether subscription-based or one-time challenge fees
Beyond these factors, traders should also research reviews and testimonials, while keeping in mind that reviews are not a substitute for regulatory oversight.
Is Prop Trading Right for You?
Prop trading is best suited for traders who are disciplined, risk-aware, and capable of consistent performance under rules.
Common pitfalls include: rushing to hit profit targets, trading oversized positions, and neglecting risk management.
Alternatives to prop trading include trading with your own smaller account, starting with low-risk futures contracts, or pursuing professional roles in institutional trading firms.
Final Thoughts on How Prop Firms Make Money
Prop firms earn money from multiple sources including challenge fees, subscriptions, profit splits, simulated commissions, and education products. Since pass rates are often low, evaluation fees provide a stable revenue stream even if few traders reach payout stages. For traders, prop firms can be a viable path, but only if approached with discipline and a clear understanding of the rules.
FAQ’s
A prop trading firm is a financial company that uses its own capital to trade financial instruments, aiming to generate profits directly for the firm.
Prop firms earn revenue through evaluation fees, profit-sharing agreements, subscription models, and additional services like educational courses and trading tools.
Many prop trading firms are legitimate, but it’s crucial to research and verify a firm’s reputation, regulatory compliance, and trader reviews before engagement.
Risks include strict evaluation criteria, potential financial losses from fees, psychological pressure, and possible withdrawal restrictions.
Yes, successful traders can earn a substantial income through prop firms, but it requires discipline, skill, and adherence to the firm’s rules and guidelines.
Consider factors like profit split ratios, evaluation processes, fee structures, platform quality, and the firm’s reputation in the trading community.
