Are Prop Firms Legitimate? Learn How They Work and How to Spot Scams

Prop firms are gaining popularity among Forex traders. They appear to be a decent choice for traders, particularly for novices. They actually seem too good to be true. As a result, many Forex traders wonder if prop firms are legitimate or just a scam.

What is a prop firm?

We should define the terms before evaluating whether or not prop firms are legitimate. Describe prop firms. Prop firms, or proprietary trading firms to use the full name, are businesses that hire and finance traders to engage in market activity on their behalf.

Scouting firms are the type of prop firms that retail Forex traders are most likely to encounter and are discussed in this article. Scouting firms are online prop firms that allocate capital to traders who then use it to trade on markets, with the profits split evenly between the company and the trader (with the trader usually taking the sizeable chunk of profits).

So, any trader can create an account and receive funding from a prop firm, and trade risk-free, with any losses being covered by the firm? That does appear to be too good to be true. Of course, it is not that simple.

Are prop firms legitimate and how do they make money?

The simple answer to the question "Are prop trading firms legitimate?" is yes. In general. The business model of prop firms is not fraudulent. But how do they make a profit?

To begin with, prop firms do not simply fund everybody who asks. They usually have a multi-stage assessment process in place to ensure that the traders they fund know what they're doing. Traders must normally follow tight restrictions and constraints in order to pass the evaluation procedure. These conditions and constraints may include a profit target, a drawdown limit, a deadline, and so on. For example, a trader may need to accomplish a 10% profit target in 30 days with a maximum drawdown of 10% or even 5% of the account value. Such rules ensure that only the most experienced traders, who are unlikely to cause the company significant losses, can get funds from the firm.

Additionally, prop firms charge fees to their traders. It could be evaluation fees, trading fees for those who have passed the evaluation, or both. Because of the fees, even a failed trader can be profitable for the prop firm. As a rule of thumb, we don’t recommend you to engage in trading for any firm that is asking for monthly fees.

But, if prop firms are legitimate, a new question arises.

Why aren't prop firms regulated?

The great majority of prop firms are unregulated. Why don't they have the same requirements as Forex brokers, for example, if they trade with real capital?

To begin with, prop firms are trading with their own capital, not that of others. This alone enables prop firms to circumvent the majority of laws.

Also, many prop firms do not provide traders with real money to manage. Even traders who have passed evaluation and been granted access to a "real" account in these organizations are still trading on a demo account with virtual capital. Technically, this means that no trading or other financial transactions are taking place. Yes, the firm may replicate successful trades made by funded traders on the firm's real account. However, those are trades done by the firm using its own capital.

Furthermore, prop firms generally emphasise that they are not financial institutions and do not provide financial services. "Financial education" is the most prevalent way prop firms present what they offer. Some authorities find that problematic, and it is probable that new legislation will require Forex prop firms to be regulated in the same way as Forex brokers are. Nonetheless, for the time being, most prop firms are able to circumvent restrictions while remaining within the confines of the law.

The absence of regulation is not always a big deal. In theory, it makes obtaining funding from prop businesses easier and less expensive. However, at the same time, it's important to not overlook the most serious issue with a lack of regulation: a lack of trader protections. That means traders are basically on their own when deciding whether or not to trust a given prop firm. As a result, the following question is critical.

How do you differentiate a good prop company from a bad one?

Do you recall how it was previously said that the response to the inquiry "are prop firms genuine?" was "yes," but with the caveat "in principle"? That is, while prop firms are not by definition scams, it does not rule out the possibility of scammers acting as prop firms. Many novice traders are drawn to prop firms, and such traders are especially appealing targets for scammers. So, how do you differentiate a good prop company from a terrible one? There are various factors to consider.

Reviews and ratings

To begin, you might read what other traders have to say about the prop firm you are considering joining. Search for the company on review websites (such as TrustPilot). Check to see whether the firm is on any lists of good prop firms. See what traders have to say about the company.

But, keep in mind that ratings and reviews can occasionally be faked. If a review appears overly good, especially if multiple similar reviews appear in a short period of time, you should be skeptical. At the same time, you should not pay attention to every negative evaluation. Traders may provide unfavourable reviews simply because they failed due to a lack of understanding of how prop firms operate and what is expected of traders who deal with such organisations.

Note that just because a company is well-known and famous does not mean that you will have no problems with it. Yet, a firm that has spent years building a strong reputation is less likely than a firm that was formed yesterday to simply grab all of the clients' money and disappear.

Finally, stick to well-known prop firms with positive ratings. Also, avoid firms with negative or no ratings, as well as those with no online presence, such as a website, postings or mentions on social media, videos by or about the firm on YouTube, and so on.

Firm’s website

Go to the website of the prop company. How clean is it? A legitimate prop company should have a well-designed website. If the firm's website is sloppy and full of spelling errors, it is most certainly a hoax ran by amateurs.

Prerequisites and constraints

You should evaluate how stringent the standards and constraints are for both the evaluation period and traders who have passed the examination. Either extreme is undesirable.

If meeting the standards required by the prop business is impossible (or almost impossible), it is a fraud designed to collect fees for failed evaluation attempts.

But, if the standards are extremely simple to achieve, this is also suspect. For all, respectable prop businesses seek to avoid losses and hence fund only the best of the best traders. Offering capital to anyone is a clearly unsustainable business concept. That is, if almost anyone can pass the firm's evaluation, the firm is most likely only interested in collecting money from as many traders as possible and has no intention of paying anything back.

If the site's standards and constraints are unclear and confusing, this is likewise a red flag. It implies that the prop firm intends to use the lack of transparency to interpret the regulations in such a manner that it can cancel the trader's account owing to a perceived breach of the rules without having to pay anything back.

Consumer service

Prop firms that want its traders to thrive should provide excellent customer service. After all, online trading is extremely quick, and seconds or even minutes can spell the distinction between profit and loss. As a result, any issues that a trader encounters should be rectified as soon as feasible. And if a company offers poor or non-existent customer service, it is most likely a hoax. Even if it is not a blatant hoax, it is still a horrible company to do business with.

Is it possible to make money with prop firms?

"Can I make money trading using prop firms?" is probably the most pressing concern for Forex traders. As with the question "Are prop firms legitimate?" The answer to this question is not as simple as yes or no. The short answer is that you can. In theory, yes. Yet, unfortunately, you most likely will not.

As previously said, prop firms only fund the top of the best. This suggests that over 70% of traders fail the evaluation stage. And just about 10% of traders make it to the profit split. Opponents of prop firms argue that the exceptionally low number of successful traders proves that the entire prop company business model is a hoax. Yet, proponents of brokerage firms counter such criticism by pointing out that less than 10% of Forex traders are successful when trading with their own money. It indicates that trading using prop businesses has almost the same chance of success as trading on your own.

But why would you want to join a prop firm if you are a great trader with a good trading strategy? Especially when trading on your own account is usually more profitable in the long run than trading with a prop business. The answer is a shortage of starting capital. Not every trader, especially those who are just starting out, has several thousand dollars to trade.

So you're a trader with a viable strategy who requires more funds to trade. Do you think you should work for a prop company? Well, you should think about the firm's criteria and constraints for the evaluation period as well as for financed traders. Normally, prop firms prioritise consistency over large returns. That is, their rules typically severely limit the amount of risk a trader may take without losing their account. There is frequently a profit target and a time constraint, particularly during the evaluation period. 

That is, short-term methods are preferred over long-term ones in prop trading. Are you sure your strategy fits inside these parameters?

You should only consider trading with a prop firm if all of the following conditions are met:

  • You have an edge, aka a successful trading approach.

  • Your strategy is capable of generating consistent returns.

  • Your strategy is compliant with the requirements and trading style of the prop firm you want to join.

How to make money with a prop firm?

When trading with a prop firm, there are additional variables that can optimise your profits while offsetting your risks.

Among the most crucial things to understand is that you are not required to trade with only one prop firm. In fact, seasoned prop firm traders advise joining as many reputable prop firms as possible. You are not putting all of your eggs in one basket this way. And if one firm has problems or turns out to be a dud, you will not lose all of your money.

Another crucial aspect is that you do not need to trade exclusively with one prop firm. The answer to the question "should I trade with prop firms or on my own?" is not binary. You can trade on your own account with your own money while also trading with a prop firm. Indeed, seasoned traders urge you to have your own account in addition to prop company accounts.

This is a frequent method used by successful prop traders:

  • Trade with at least two prop firms.

  • Withdraw funds from your prop firm accounts on a monthly basis to avoid losing them if the firm runs into problems or goes bankrupt.

  • Transfer the withdrawn amounts to your own account to help you increase your own capital.

That way, you reduce the danger of losing all of your capital should one of the prop firms defaults, while also compounding your personal capital. And, if you are a successful trader (which you must be to trade with prop firms), you can eventually build your money to the point where you no longer need prop firms and can trade entirely on your own.

Julia Harbough
Julia Harbough

Lifelong beer maven. Typical coffee buff. Lifelong travel guru. Lifelong beer expert. Web scholar.

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