Undercapitalized Prop Firms and Risk to Traders
The prop firm ecosystem is not without blemish. Given the low barrier to entry and the availability of many retail traders ready to try their luck in prop trading, the ecosystem has fallen victim to some bad actors. Unfortunately, the bad actors bring out the industry's ugly side in a way that not only damages its reputation but also discourages would-be successfulprofessional prop traders. Some downsides include the following:
Given the lucrative nature of the industry for prop firms, new under-capitalized businesses have entered the ecosystem. Prop firms without sufficient capital are a problem because the prop trading business is capital-intensive. The firms require an adequate runway to withstand sudden shocks, given the high-risk and volatile nature of the business. These undercapitalized prop firms expose traders to misery in the event of collapse under the weight of an unsustainable drawdown.
Unhealthy Competition and Unsustainable Practices
Because undercapitalized prop firms need quick returns to grow their capital, they tend to undercut competitors to scoop more traders. For example, they charge unsustainably low fees to lure traders. Also, they may promise traders ridiculous returns. Given their inadequate capital, the firms may not have sufficient eyes to monitor traders' positions or manage risk. Furthermore, such unscrupulous players tend to rely on evaluation fees from new traders to compensate existing ones. Their operations are no different from multi-level marketing (MLM) schemes, meaning they are likely to fold when the new evaluation fees cannot compensate the profitable existing traders.
Perusing online forums like ForexFactory reveals that some prop firms use tricks to shortchange traders. For example, some firms change rules constantly without prior notification to traders. Other firms may expel traders on flimsy grounds, denying them access to their earnings.
Most importantly, the prop trading industry is largely unregulated, meaning most prop firms operate without proper licenses. The issue here is that unregulated firms do not inspire confidence in traders. Specifically, users of such platforms do not enjoy any form of protection in case of a crisis. Moreover, if an unregulatedprop firmrug-pulls traders, the traders do not have a legal means of recourse.
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