The term proprietary trading is used in content of financial institutions or banks engaging in options, futures, stocks, currencies, commodities and other derivative instruments with its own money or own account.
Financial institutions and banks traditionally were engaged in accepting deposits from clients and lending the same in higher ratio. Investment banks have played a major role in raising funds for its clients. They play a big role in helping clients to find buyers for stock issues. Banks acted as guarantor for buying shares of their clients when the stock issue is under subscribed. Several banks offer portfolio management service and trading facilities to the clients. The banks or financial institutions are engaging in trading while offering these services. For this they charge fees or commissions from the clients.
Prop trading firms adopt strategies that are technical trading algorithms used for different risk strategies and arbitrage. It is done for the benefit of the trading firm also and not alone for the benefit of the clients. This form of trading generally includes large capital outlays as well as high volumes of stock trading. These are mainly performed by the hedge funds and the investment banks. This form of trading is different from majority of the trading activities because it involves no brokerage activity or client relationship. Prop trading has emerged to be an important source of income for firms undertaking that activity.
Here we shall discuss the important strategies the good prop trading firms adopt :
Most of the prop trading involves arbitrage. Merger arbitrage, statistical arbitrage, index arbitrage, volatility arbitrage are some of the popular forms of trading. With lesser use of the “open country”, arbitrage is done directly from the institution computers to the computer order placement on the exchange floor.
Choice of Instruments for Prop Trading Firms :
Trading happens in bonds, futures and stocks. Positions are described as high frequency or low frequency. Arbitrage is constantly underway because of the depth and size of the United States Treasury bond market. Trading today consists of carry trade (holding securities with higher income than the cost of the funds required supporting the position), option trading between stock, trading currencies to reduce the funding costs, buying future contract and selling options on the positions for income while hedging underlying future contracts.
The main purpose of engaging in proprietary trading is to make profit with the actual market movements against the earning commissions and fees with trading on behalf of the clients. Many financial institutions are appointing freelance traders to trade on their behalf and to pay a lump sum amount based on the trading performance.
Prop trading is not free from criticism. For more information on prop trading you can look into the resources available online. If you are thinking of joining a proprietary trading firm, it is imperative that you look into the valid and useful information online and know about the basics of prop trading.
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