Even if you aren't an active trader, there's a good chance you have some exposure to the stock market. In fact, almost everyone does. It may be through mutual funds or your IRA. But what if you want to turn that passive trading into an active strategy? If you want to be an active trader in individual stocks, you really only have two general paths: Become a professional trader (prop trader) or trade in a retail account.
Those looking to break into the day trading industry have a choice to make: open an account with a proprietary trading firm — also known as a "prop shop" — or one with a retail online broker? When evaluating account options, independent day traders often compare costs and account features but fail to realize the products are not exactly the same.
In this article, we will look at the key differences between proprietary trading and retail trading accounts to make comparisons more straightforward.
Retail vs. Prop Trading
Before we look at what sets these two accounts apart, it's important to first understand how they differ.
The capital that's traded in a prop trading account is usually that of a brokerage firm or hedge fund. Trades made through this account are typically speculative in nature. Products traded are usually derivatives or other complex investment vehicles. Trading activity is usually limited by a risk manager and by the amount of money a firm has.
Retail trading accounts, on the other hand, are much simpler. A retail trader will choose a broker, open up an account and make a deposit. After that, the trader can simply start making trades. Since you are a customer of the firm and you're using your own cash rather than that of a firm, there's far more flexibility on what trading activity you can undertake as well as how and when you can do it.
Comparing Fees & Commissions
Retail brokers have a wide range of fee structures that tend to be very competitive. Most firms charge a flat per-trade commission along with a platform fee unless day traders meet certain minimums when it comes to trading volume or account size. These accounts may also come with ancillary fees like inactivity fees or account transfer fees. After the fees and commissions are all collected, the profits from your successful trades are yours to keep.
Prop shops tend to be more competitively priced than retail brokers with per share fees that decrease as trading volume increases. The firms may also charge a software or desk fee — although it is typically provided at-cost to day traders. With prop accounts, remember that the firm will likely take a portion of your profits. After all, you are trading the firm's capital and not your own.
Either way, remember to inquire about the full fee schedule because they do vary. Knowing how much you'll have to pay is an important part of opening and setting up your account.
Comparing Leverage & Buying Power
Retail brokers provide day traders with margin accounts that are subject to certain margin requirements and securities regulations. For example, Regulation T may limit the amount of leverage used in a retail account. Day traders must also have at least $25,000 in equity to execute more than three-day trades in a rolling five-day business period.
Prop shops provide traders with leverage based on the risk capital deposited and the firm’s own policies. Day traders with less than $25,000 don’t have to worry about minimum equity requirements and others have access to more capital than they would with a retail account. Buying power often increases over time if a trader performs well.
Taking Advantage of ECN Rebates
Most Electronic Communication Networks (ECNs) provide rebates to traders who add liquidity and they also charge higher fees to traders that remove liquidity from the market. Retail brokers generally don’t pass on these rebates to day traders since they route orders to the lowest cost destinations.
Prop shops enable day traders to take advantage of ECN rebates as a trading strategy. In fact, day traders may seek opportunities to add liquidity and collect rebates — all of which can be a significant source of income and influence order routing.
Comparing Educational Resources
Retail brokers provide a good level of educational resources, including training videos, trading seminars, visual media, and articles. These resources are designed to help traders understand the market and ultimately increase their trading volume.
Prop shops have much more incentive to educate traders since their own capital is at stake. In general, the training provided by these firms is much more hands-on and valuable. Traders should be cautious, however, with firms that charge upfront for training services.
One of the main differences between the two accounts is whether you require a license to trade. Professional trading requires licensing, which means the people making trades on your behalf — or you, if you're a prop trader — may be required to obtain a securities license for a prop trading account. On the other hand, retail accounts don't require any training or paperwork. That's because you're trading your own capital. This is one key benefit of using a retail trading account.
Retail brokers provide basic access to many assets and trading strategies such as stocks, options, and futures. The problem is that traders operate without outside resources, which can make it difficult to buy certain assets or execute certain strategies.
Prop shops can help traders identify shares on a threshold list for short selling, access liquidity in dark pools and access buying power to execute on more opportunities. These account features can provide a big advantage over the long run.
The Bottom Line
Most day traders begin with retail brokers due to their popularity, but ignoring prop shops can be a costly mistake in the long run. Prop trading accounts at firms such as T3 Live, Avatar Securities, Assent LLC, and Hold Brokers may be attractive options for some day traders. It’s important to carefully consider these differences when deciding between retail and prop trading accounts. For further information about brokers, see Investopedia's list of the best stock brokers for day trading.