Introduction

Risk management is very different in proprietary trading and hedge funds. In a prop trading firm, a trader's loss is basically the firm's money. The trading desk may be very aggressive. While on the contrary, a hedge fund manager is responsible for the finances of other people. This creates a massive psychological difference - it is the difference between playing a high-stakes game with someone else’s money vs spending the own lifetime savings. The manager should be more careful along with strictly following the Financial Market Regulation. If the fund loses a significant amount, investors will take their money.

If you are a beginner looking for more trading knowledge, check out our ‘Day Trading for Beginners Guide’ guide on the best ways to start your journey.

What is Proprietary Trading?

Proprietary trading or prop trading for short, means that a firm lets its traders operate with their money rather than that of clients. These prop trading firms specialize in supplying trading opportunities in financial markets such as forex, stocks, crypto, futures and other financial instruments and unlike traditional brokerages, they do not handle external client’s money.

The goal is clear: traders use the money of the prop trading firm to make profits, which are then divided between the trader and the firm. (the trader always gets the huge share of the profit). This means the trading environment encourages you to focus solely on making money rather than spending time on administrative tasks like meeting clients or marketing.

These prop firms come up with different evaluation systems to choose their traders, like 1-step, 2-step and 3-step challenges which each causes certain profit targets and risk rules. Besides, they give direct funded trading accounts to experienced traders, these traders can trade without putting their own money at risk. In fact, traders can get into a larger firm, funded account and dedicate themselves to performance and risk management only.

Mastering the Markets - Examples of Prop Traders

A great method to grasp it is to discover what kinds of individuals actually are those who trade for such firms in the real world. Each trader takes the firm's money and does it in a different way to find success in the markets. Here are the most common examples:
The Scalper: The trader who uses this style is the one who makes hundreds of rapid trades within a day without waiting for more than a few seconds. The goal of them is to make just a tiny bit of profit on each trade. To do so successfully they uses fast computers and the firms large capital.
The Arbitrage Trader: Such a trader looks for a stock that is priced differently at two different markets. At the same time, they purchase the stock where it is cheaper and sell it where it is higher.
The Quant Trader: This is the trader who programs the computer code. This code is based on a mathematical model and it buys and sells automatically without human intervention.

What are Hedge Funds?

A hedge fund is similar to a large pot of money. This pot is filled with Hedge Fund Investor Capital. The money comes from very wealthy people, large banks and pension funds. A professional manager oversees the money and tries to make it increase over time.

Hedge funds have many rules to follow. They have to be accountable to the people who invested the money. They also have a particular way of getting paid called the Two and Twenty Fee Structure. They charge 2% of the total money annually only for the management. Afterward, they take 20% of the profits made.

Growing Wealth - Examples of Hedge Fund Strategies

Hedge funds go for the long-term using complex methods to grow wealth. They manage money for others, so their strategies tend to be very structured. In these offices, traders take their work very seriously - every decision is supported by careful study and a team of experts. Below are the common ways they trade:
The Macro Trader: A macro trader is someone who scrutinizes large, scale factors such as countries, interest rates and worldwide news. One of their moves may be to wager that a country's currency will become more valuable next year.
The Long/Short Equity Trader: A trader of this type buys the stocks that they consider to be good (long) and at the same time short, sells the stocks that they think are bad (short). Their goal is to make money even if the entire market is going to be down.
The Event-Driven Trader: The trader who does this kind of trading is waiting for a big event, like the merger of two companies. They trade on the assumption that the particular event will change the price.

Proprietary Trading vs Hedge Funds: Key Difference Between

There are clear differences between prop trading and hedge funds with it’s own pros and cons. Here are the main differences between prop trading and hedge funds explained in a clear manner to help you understand better:

Trading Risk and Rules for Prop trading and Hedge Funds

Risk management in proprietary trading vs hedge funds is different to a great extent. A prop firm is the one where, if a trader loses money, it is only the firm’s own wallet that is hurt. Therefore, they can be very aggressive.
On the other hand, a hedge fund manager is the one looking after other trader’s life savings. So he must be more careful. Also, they are required to follow the regulations of the financial market very strictly. If a hedge fund manager makes a mistake, the consequences are severe. They could damage their professional reputation and negatively affect the financial stability of the traders who invested with them. In case they lose too much money, their investors will withdraw their money and they will be forced to leave.

Conclusion - Which Trading Path Should You Choose?

When deciding between a proprietary trading vs hedge funds career path for traders, one of the main things to consider is your personal financial goals and trading preferences.

In case you like to trade on your own and want to keep a major part of what you make, prop trading is the way to go. After showing that you are a good trader, you can simply get started with Direct Funded Trading Accounts. Here, there is no Hedge fund management fees vs prop firm payout rules to worry about. What you do is just trade and split the profit with the house.

If you are the kind of person that enjoys working in a big team, receiving a steady salary and having long-term plans, then a hedge fund might be more suitable. Using Institutional Investment Strategies you will be able to help others build wealth over many years.
Also, whichever you decide, being highly skilled in math and maintaining your composure during market fluctuations are some of the requirements for both paths.

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