Prop trading or proprietary trading refers to the trading of any financial instrument with a firm’s own money and not the money of its depositors or clients. The purpose of this type of trading is to earn profits for the firm by using a variety of arbitrage strategies, fundamental analyses or other forms of analysis.[1]
[1] https://www.blackwellglobal.com/becoming-proprietary-trader/
Touted as one of the main reasons for the Global Financial Crisis in 2008 that wiped over $12 trillion from the global economy when all was said and done, prop trading is certainly not for the faint-hearted. Post GFC, the regulatory authorities in the US enacted the Volker Rule, that banned US banks from participating in forex prop trading, in fact, any prop trading at all.
However, Australian banks and other financial institutions and trading houses around the world can participate in prop trading and do so successfully around the world in many markets.
One of the more attractive markets for proprietary trading is Forex prop trading. Similar to participation in the forex trading markets as part of a fund or via an online trading platform, Forex trading, foreign exchange trading or currency trading is the buying and selling of currencies on the forex market with the aim of making a profit[1].
As with all forms of prop trading, doing so in a forex prop trading scenario is just engaging in the above trading of currencies, using the firm’s own money, not that of depositors or clients. This opens the company up to exposure on their positions rather than that of their client’s investments.
When it comes to leveraged positions, this refers to the use of debt to undertake investment or project. The result is to multiply the potential returns from a project. At the same time, leverage will also multiply the potential downside risk in case the investment does not pan out.[2]
When it comes to the trading of forex prop trading, they can be leveraged in a number of ways including options, futures and margin accounts that only require a fraction of the potential investment to take up a position.
The downside for many companies with this style of investing – banks included – which was found during volatile market conditions such as the GFC, is that when a leverage position turns against even a ‘sure bet’ position in the market, the individual or company that holds the position are exposed to a much larger payout should the holder of the opposite position wish to exercise their position.
When it comes to Forex prop trading, not all positions by any means are leveraged and provide an active way for firms to increase their liquidity and bottom line performance.
