Prop trading can seem overwhelming at first, but understanding the core terms and rules is essential for success. Whether you're aiming to pass a trading evaluation or manage risk in a funded account, this glossary simplifies the jargon to help you trade confidently. Hereâs what you need to know:
- Prop Trading Basics: Trade with a firm's capital, share profits, and follow strict rules like max drawdown and daily loss limits.
- Risk Management: Terms like trailing drawdown, position sizing, and leverage are key to protecting your account.
- Trading Rules: Be aware of restrictions like news trading, weekend holding, and algorithmic policies to avoid violations.
- Costs and Execution: Understand spreads, commissions, and slippage to calculate your true profits.
- Market Instruments: Forex, stocks, indices, commodities, and crypto each have unique trading dynamics.
Prop Firms: What You Need to Know
Basic Concepts in Prop Trading
To get a solid grasp of prop trading, itâs crucial to understand its core principles. One of the most important tools in this field is simulated trading, which lets traders refine their strategies in a realistic setting without risking actual money.
Simulated Trading and Demo Accounts
Simulated trading involves using virtual funds to trade in an environment that mirrors real market conditions. This method plays a key role in prop trading, especially in evaluation challenges, where traders showcase their skills and risk management abilities without incurring financial losses. Demo accounts, a common feature of simulated trading, provide an excellent way for newcomers to practice placing orders and get comfortable with trading platforms.
Risk Management and Trading Rules
Risk management is the cornerstone of success in proprietary trading. For beginners, understanding the specific terms and rules surrounding risk controls is a must. Prop trading firms enforce strict guidelines to safeguard their capital while still allowing traders the flexibility to aim for profits.
Max Drawdown, Trailing Drawdown, and Daily Loss Limits
Max drawdown is the maximum amount youâre allowed to lose from your accountâs starting balance before breaking the rules. For instance, if you have a $100,000 account with a 10% max drawdown rule, your losses cannot exceed $10,000. This means your account equity must always stay above $90,000.
Trailing drawdown adjusts based on your accountâs highest balance, creating a moving floor for your equity. Letâs say you start with $100,000 and grow your account to $105,000. With a 10% trailing drawdown, your account cannot fall below $94,500 (10% below your new high of $105,000). The drawdown âtrailsâ your profits upward but never moves back down.
Daily loss limits set a cap on how much you can lose in a single trading day, based on the previous dayâs closing balance. For example, with a $100,000 account and a 5% daily loss limit, you cannot lose more than $5,000 in one day. This limit resets at the start of each trading session, helping to prevent rash decisions that could erase weeks of gains.
Hereâs the key distinction between these metrics: max drawdown is tied to your starting balance, trailing drawdown is based on your highest balance, and daily loss limits reset daily, using the prior dayâs closing balance as a reference point.
Leverage, Lot Size, and Position Sizing
Leverage lets you control larger positions than your account balance would normally allow, magnifying both potential profits and losses. For example, in forex trading, 1:100 leverage means you can control $100,000 of currency with just $1,000 in your account. While leverage can boost your returns, it also increases your exposure to risk.
Lot size refers to the number of trading units in a position. In forex, a standard lot equals 100,000 units of the base currency, while a mini lot is 10,000 units, and a micro lot is 1,000 units. For a EUR/USD trade, one standard lot means youâre trading âŹ100,000 against US dollars.
Position sizing is about calculating the right trade size based on your account balance and risk tolerance. Many successful traders limit their risk to 1-2% of their account per trade. For a $100,000 account, this translates to risking $1,000-$2,000 per trade. Your lot size is then determined by your stop-loss distance and the amount youâre willing to risk.
These three concepts work together to help you manage risk effectively. For example, using higher leverage means youâll need smaller position sizes to keep your risk level in check. Similarly, larger lot sizes amplify both potential profits and losses with every pip movement.
Trading Rules: News, Weekend Holding, and Algorithmic Policies
Prop trading firms enforce strict rules around trading during news events to avoid excessive risk during volatile economic announcements. Typically, traders are prohibited from opening new positions within 2-5 minutes before and after key events like Non-Farm Payrolls, Federal Reserve decisions, or GDP reports. For especially impactful announcements, some firms extend this restriction to 15-30 minutes.
Weekend holding policies vary by firm. Some firms forbid holding positions over the weekend due to the risk of price gaps when markets reopen on Monday. Others may allow weekend positions but often require reduced position sizes. Price gaps can lead to unexpected losses or trigger stop-losses when markets react to weekend news.
Firms may also allow the use of Expert Advisors (EAs) but often require pre-approval. Strategies like high-frequency trading or martingale systems are generally restricted. Additionally, many firms prohibit copy trading or signal services, requiring all trades to be based on the account holderâs own analysis.
Other common rules include restrictions on hedging (holding both long and short positions in the same instrument), minimum and maximum holding periods for trades, and bans on strategies like scalping during low-liquidity periods. These policies aim to ensure fair trading practices and protect the firmâs capital while maintaining realistic trading conditions.
Understanding and adhering to these rules is essential to keeping your funded account intact and thriving.
Order Types, Costs, and Execution
To succeed as a prop trader, you need to understand how to place trades, the costs involved, and how orders are executed. These factors directly influence your bottom line and help you manage risk effectively. Letâs break it down.
Order Types: Market, Limit, and Stop Orders
Market orders are designed for immediate execution at the current market price. Theyâre ideal for quick entry or exit, but during volatile periods, slippage can occur. For instance, if youâre buying EUR/USD, youâll pay the current ask price, while selling means youâll receive the bid price.
Limit orders give you more control by letting you set the exact price youâre willing to pay or accept. A buy limit order executes at your chosen price or lower, while a sell limit order executes at your price or higher. For example, if EUR/USD is trading at 1.0850 and you set a buy limit at 1.0840, the order will only execute if the price drops to 1.0840 or below. While limit orders provide better price control, they donât guarantee execution.
Stop orders activate once a specific price is reached, turning into market orders. On the other hand, stop-limit orders become limit orders at the trigger price, offering more precision but with the risk of not being filled. A sell stop order, often used as a stop-loss, is placed below the current market price to limit losses on long positions.
Now that you know the basics of order types, itâs time to look at the trading costs that can impact your profitability.
Understanding Trading Costs
Trading isnât free, and understanding the different costs involved is key to managing your profits effectively.
- Spread: This is the difference between the bid and ask prices. For example, in forex, EUR/USD might have a 2-pip spread. Spreads can widen during low liquidity or news events, increasing your trading expenses.
- Commissions: These are fixed fees charged per trade or per lot. For instance, a broker might charge $3.50 per standard forex lot or $0.50 per 1,000 stock shares. Accounts with commissions often offer tighter spreads, balancing the cost.
- Swap or financing costs: If you hold positions overnight, you may incur swap fees based on the interest rate differential between the currencies. For example, being long EUR/USD could result in a negative swap if the European Central Bankâs rate is lower than the Federal Reserveâs.
- Slippage: This happens when your order fills at a price different from what you expected, especially in fast-moving markets. For example, placing a market order to buy EUR/USD at 1.0850 but being filled at 1.0852 means youâve experienced 2 pips of negative slippage. Using limit orders can help reduce slippage, though it comes with the risk of not being filled.
Once youâre familiar with costs, understanding how your trading platform executes orders becomes the next step.
Execution and Platforms
Execution quality can make or break your trading strategy, and much of it depends on liquidity and the platform you use.
- Liquidity: This refers to how easily you can buy or sell an asset without impacting its price. Major currency pairs like EUR/USD are highly liquid, meaning orders are filled quickly with minimal slippage. Exotic pairs, however, may have lower liquidity, leading to wider spreads and slower execution.
- Partial fills: If you place a large order in a low-liquidity market, only part of it might execute immediately. For instance, placing an order for 10 standard lots but only having 3 lots filled leaves the remaining 7 as an open order until theyâre either filled or canceled.
When it comes to platforms, your choice often depends on the tools provided by your prop firm. Here are some popular options:
- MetaTrader 4 (MT4): A favorite among forex traders for its simplicity and support for automated trading via Expert Advisors.
- MetaTrader 5 (MT5): An upgraded version of MT4 with additional timeframes and enhanced backtesting capabilities.
- cTrader: Known for advanced charting tools and Level II pricing, which shows market depth.
Mastering your platformâs features - like hotkeys and order management tools - can give you an edge in fast-moving markets where every second counts.
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Market Instruments and Trading Access
Building on the basics of order execution and trading costs, it's essential to understand the variety of instruments available to proprietary traders. Each market operates differently, and understanding these distinctions can help you align your trading strategies with the instruments that suit your style. Here, we'll explore some key instruments and how they respond to economic events, providing insights into their role in prop trading.
Common Instrument Categories
Forex (Foreign Exchange) is the world's largest and most liquid market, operating 24 hours a day during weekdays, making it accessible across various time zones. Forex traders often lean on technical analysis and price action rather than fundamental analysis for short-term strategies.
When trading forex, you're essentially exchanging one currency for another. Popular pairs like EUR/USD, GBP/USD, and USD/JPY offer tight spreads and high liquidity, making them favorites among traders.
Stocks (Equities) represent ownership in publicly traded companies and are traded on major exchanges like the New York Stock Exchange and NASDAQ. Unlike forex, stock trading relies heavily on fundamental analysis to assess a company's value. Factors like earnings reports, revenue growth, and industry trends play significant roles in stock price movements.
For example, if Apple reports strong iPhone sales, its stock price might surge. However, broader issues like regulatory concerns in the tech sector could still drag down even high-performing companies.
Indices track the performance of a group of stocks within a specific exchange or sector. Well-known indices include the S&P 500, which covers 500 large U.S. companies, and the NASDAQ-100, focusing on major non-financial companies listed on NASDAQ. Indices offer a way to gain diversified exposure to the market.
Many beginners prefer trading indices because they reduce the risk tied to individual companies. For instance, if one company in the S&P 500 underperforms, the other 499 can help balance out the impact.
Commodities include raw materials like oil, gold, silver, and agricultural products such as wheat. Prices in this market are largely driven by supply and demand dynamics, weather conditions, and geopolitical events, making fundamental analysis crucial.
For instance, oil prices often rise during geopolitical tensions, while gold tends to perform well during periods of economic uncertainty. Staying informed about global events and seasonal patterns is key to success in commodity trading.
Cryptocurrencies like Bitcoin and Ethereum operate on decentralized networks and are known for their high volatility. Crypto markets never close, offering 24/7 trading opportunities but also presenting unique risks.
For prop traders, understanding these instruments broadens your strategic range, helping you adapt to different market conditions and meet the expectations of funded trading programs.
| Instrument Category | Key Characteristics | Best For |
|---|---|---|
| Forex | High liquidity, 24-hour trading, technical analysis focus | Traders seeking constant access and short-term strategies |
| Stocks | Company-specific analysis, fundamental factors matter | Traders who enjoy researching individual companies |
| Indices | Diversified exposure, reduced single-company risk | Beginners or those seeking broader market exposure |
| Commodities | Influenced by supply/demand and global events | Traders following economic and geopolitical trends |
| Cryptocurrencies | High volatility, 24/7 trading | Risk-tolerant traders comfortable with rapid price changes |
Market Hours and Economic Events
Knowing when markets are active and how economic events influence trading is essential for success.
Forex sessions overlap to create periods of heightened activity. For instance, the London session (3:00 AM - 12:00 PM EST) often sees the highest trading volume, especially during its overlap with the New York session (8:00 AM - 5:00 PM EST). The Asian session (7:00 PM - 4:00 AM EST) is typically more active for currency pairs involving the Japanese yen.
Stock markets operate within set hours. The New York Stock Exchange and NASDAQ are open from 9:30 AM to 4:00 PM EST on weekdays. Pre-market trading begins at 4:00 AM EST, while after-hours trading extends until 8:00 PM EST, though liquidity is generally lower outside regular hours.
Rollover times in forex occur daily at 5:00 PM EST. At this time, positions held overnight may incur swap fees based on interest rate differences between the currencies in the pair. Many traders close positions before rollover to avoid these fees, especially when the swap is negative.
Economic events can significantly impact prices across all markets. Some key events to monitor include:
- Non-Farm Payrolls (NFP): Released on the first Friday of each month at 8:30 AM EST, this report shows U.S. employment changes. Strong NFP data often boosts the U.S. dollar, while weak data can cause it to decline.
- Consumer Price Index (CPI): A monthly report released at 8:30 AM EST that measures inflation. Higher-than-expected inflation can lead to interest rate hikes, affecting currencies and stocks.
- Federal Reserve meetings: Held eight times a year, these meetings can cause significant volatility across forex, stocks, and commodities. Interest rate decisions and comments from the Fed Chair are closely watched.
- Earnings seasons: Occurring quarterly, these periods impact individual stocks and broader indices. Companies usually release earnings reports either before the market opens or after it closes to minimize disruptions during trading hours.
Many proprietary trading firms impose restrictions during high-impact news events or require wider stop-losses to account for increased volatility. Understanding market hours and the timing of economic events is crucial for selecting instruments that align with your trading strategy and meet prop firm guidelines.
Complete AâZ Glossary of Prop Trading Terms
Hereâs a detailed glossary to help you understand key terms in proprietary trading. Think of this as your go-to reference for decoding the jargon and concepts that define the world of prop trading.
Account Balance: The total funds in your account from closed trades. It doesnât include open positions. While your balance remains unchanged until trades are closed, equity varies as open positions fluctuate.
Algorithmic Trading: Trading that uses software to execute strategies based on predefined rules. Some prop firms support automated trading but may require disclosure or enforce specific guidelines.
Ask Price: The price sellers are willing to accept for an asset, also known as the "offer price." Itâs usually higher than the bid price, creating the spread.
Balance vs. Equity: Balance reflects closed trade outcomes, while equity accounts for open positions. For example, if your balance is $100,000 and you have a $500 unrealized loss, your equity stands at $99,500.
Basis Point: Equal to 0.01% or one-hundredth of a percent. For instance, a 25-basis-point increase in a swap rate means a rise of 0.25%.
Bid Price: The highest price buyers are willing to pay for an asset. The gap between the bid and ask prices forms the spread, which contributes to trading costs.
Break-even: The point at which profits match losses, leaving a net gain of zero. Achieving break-even after a loss can indicate better risk management.
CFD (Contract for Difference): A derivative that lets you speculate on price movements without owning the asset. Many prop firms provide CFDs for indices, commodities, and stocks.
Commission: A fixed fee per trade, often expressed per standard lot. For instance, a $7 commission on a $100,000 forex trade means $7 is charged to open and close the position.
Daily Loss Limit: The maximum youâre allowed to lose in a single trading day, typically calculated from 12:00 a.m. to 11:59 p.m. ET. For example, a 5% limit on a $100,000 account means a $5,000 daily cap.
Drawdown: The reduction in account value from its peak to its lowest point.
ECN (Electronic Communication Network): A system that matches buy and sell orders electronically. ECN brokers often offer tighter spreads but charge commissions.
Economic Calendar: A schedule of major economic events that can influence markets. Examples include the Non-Farm Payrolls report (released monthly at 8:30 a.m. EST) and Federal Reserve meetings.
Equity Curve: A graph showing account value over time, tracking profits and losses. A consistently upward trend signals steady performance.
Evaluation Phase: The initial test where traders prove their skills to earn a funded account. This phase often has two stages with varying profit targets but consistent risk rules.
Funded Account: A trading account provided by a prop firm after passing the evaluation. Traders use the firmâs capital and share profits based on agreed splits.
Futures: Standardized contracts to buy or sell an asset at a set price on a future date. A popular example is the E-mini S&P 500, with a tick value of $12.50.
Hedging: Opening positions to offset potential losses. Some firms restrict hedging, while others allow it under specific conditions.
Leverage: The ratio of borrowed funds to your own capital. For example, 1:100 leverage on a $100,000 account means you only need $1,000 in margin, but a 1% market move could cost $1,000.
Limit Order: An order to buy below or sell above the current price. It ensures a specific price but doesnât guarantee execution.
Lot Size: The standard unit of trading. In forex, one standard lot equals 100,000 units of the base currency. Mini and micro lots are 10,000 and 1,000 units, respectively.
Margin: The deposit required to open a leveraged position. For example, a $100,000 position with 1:100 leverage requires a $1,000 margin.
Margin Call: A request for additional funds when equity falls below required margin levels, often a warning of rule violations.
Market Order: An order to buy or sell at the best available price. While execution is guaranteed, the price isnât, especially in volatile markets.
News Trading Rule: Restrictions on trading around major economic announcements. For instance, some firms ban trading two minutes before and after key events to avoid extreme volatility.
Payout Cycle: The schedule for distributing profits to traders. Common cycles are bi-weekly or monthly, with the first payout often delayed by 14 days after funding.
Pip: The smallest price movement in forex, typically 0.0001 for major pairs. For example, a move from 1.1000 to 1.1001 in EUR/USD equals 1 pip, worth about $10 per standard lot.
Position Sizing: Calculating trade size based on risk tolerance. For example, with a $500 risk limit and a 25-pip stop loss, youâd trade about 2 standard lots.
Profit Split: The percentage of profits shared between the trader and the prop firm. Splits often range from 70/30 to 90/10, improving with performance.
Refund Policy: Terms for returning evaluation fees after funding. Many firms refund fees with the first payout, ranging from $100 to $500 based on account size.
Revenge Trading: Emotional trading after a loss, often leading to more mistakes. Taking a break after hitting half your daily loss limit can prevent poor decisions.
RTH (Regular Trading Hours): Standard trading hours for specific instruments. For example, E-mini S&P 500 futures trade from 8:30 a.m. to 3:15 p.m. Central Time during RTH.
Scaling Plan: A strategy to increase account size or improve profit splits by meeting performance milestones. For instance, moving from a $100,000 to a $200,000 account.
Slippage: The difference between expected and actual execution prices, often occurring during high volatility or low liquidity.
Stop Loss: An order to close a losing trade at a set price, limiting losses and protecting equity.
Stop Order: An order that becomes a market order once the stop price is reached, used for both stop losses and breakout entries.
Swap/Overnight Financing: Interest applied to positions held past 5:00 p.m. EST in forex. Positive swaps add to profits, while negative swaps increase costs.
Take Profit: An order to lock in gains by closing a winning position at a predetermined price.
Tick: The smallest price movement for an instrument. For E-mini S&P 500 futures, one tick is 0.25 points, worth $12.50 per contract.
Trailing Drawdown: A loss limit that rises with new equity peaks but doesnât decrease. It may be based on balance or equity highs.
Violation: Breaking a prop firmâs rules, often resulting in account termination. Common violations include exceeding loss limits or trading during restricted times.
Win Rate: The percentage of profitable trades out of total trades. A high win rate is appealing but should be evaluated alongside average gains and losses.
Key Takeaways for Beginners
Getting a solid grip on prop trading terminology is essential for standing out as a successful trader. Many traders fail evaluations not because their strategies are flawed, but because they misunderstand or violate rules. Knowing the key terms and how they apply to your trading can help you avoid costly mistakes and keep you on track. Letâs recap the most critical points.
The seven terms you need to know are evaluation phases, funded accounts, profit splits, max daily loss, max drawdown, trailing drawdown, and payout cycles. These concepts arenât just jargon - they directly influence your ability to pass evaluations and determine how much profit youâll actually take home.
Understanding risk parameters in dollar terms is vital for daily trading decisions. For example, on a $50,000 account, risking 0.5% per trade equals $250. If your stop loss is 25 pips, youâd typically trade about one standard lot in EUR/USD, where each pip equals $10. However, during volatile periods, spreads and slippage (1-2 pips) might force you to reduce your position to 0.8-0.9 lots to stay within your $250 risk limit. These calculations are non-negotiable if you want to maintain control over your account.
Execution costs, such as spreads, commissions, and slippage, eat into your profits and can make or break your evaluation progress. Spreads widen during market volatility, commissions stack up with every trade, and slippage can turn a profitable strategy into one that barely breaks even. Keeping these costs in mind is essential to hitting profit targets and advancing through evaluation phases.
Familiarity with your trading platform is another crucial aspect. Whether youâre using MT4, MT5, cTrader, or TradingView, you need to understand how orders are executed and stops are triggered. A simple mistake, like misplacing a decimal point or miscalculating lot size, can lead to immediate violations of daily loss limits - especially when leverage magnifies every error.
Donât overlook firm-imposed trading restrictions designed to protect their capital. For example, some firms prohibit trading during high-impact news events. Use an economic calendar to mark these restricted windows and avoid trading during those times if required by your firmâs rules.
Your income timeline is also tied to payout cycles, which may occur weekly, bi-weekly, or monthly. Minimum payout thresholds and challenge fee refunds often depend on reaching funded status and completing your first payout. These factors play a big role in calculating your break-even point for the entire evaluation process.
To stay on top of everything, your daily checklist should include:
- Tracking your remaining daily loss capacity
- Monitoring current drawdown levels
- Checking for upcoming news restrictions
- Calculating total trade costs, including slippage
- Verifying platform settings before placing trades
Leverage should be treated as a tool to size your positions within your risk limits - not as a shortcut to higher profits.
When you fully understand key concepts like trailing drawdown (which moves with equity highs), profit splits (applied to net profits after costs), and the impact of rule violations, youâll approach trading with the precision required by prop firms. Mastering this vocabulary and mindset prepares you to think and act like a funded trader long before you officially become one.
FAQs
Whatâs the difference between max drawdown, trailing drawdown, and daily loss limits in prop trading?
Max Drawdown, Trailing Drawdown, and Daily Loss Limits Explained
Max drawdown represents the deepest decline an account can experience from its peak balance to its lowest point over a given period. Itâs a long-term metric that highlights the maximum level of risk an account can handle before recovery is anticipated.
Trailing drawdown, on the other hand, is a flexible risk management tool that adjusts as your account grows. It moves upward as profits increase, effectively locking in gains at key milestones. However, it doesnât move back down, allowing for some losses while still safeguarding previous profits.
Daily loss limits are designed to cap the amount you can lose in a single trading day. These limits reset every day, acting as a safeguard against sudden, substantial losses.
Each of these tools serves a unique purpose in risk management: max drawdown addresses long-term risk, trailing drawdown adapts to account growth, and daily loss limits focus on controlling short-term losses within a single trading session. Together, they create a comprehensive approach to protecting your account.
How do costs like spreads, commissions, and slippage impact my earnings as a prop trader?
Trading costs like spreads, commissions, and slippage can quietly eat away at your profits as a prop trader. Letâs break these down:
- Spreads represent the gap between the bid and ask prices. When markets are volatile, this gap often widens, making it pricier to enter or exit trades.
- Commissions are the fees you pay per trade. If youâre a high-frequency trader, these charges can stack up fast.
- Slippage happens when your trade gets executed at a price thatâs different from what you anticipated. This is common in fast-moving markets and can shrink your profits.
Keeping these costs in check is crucial. Even minor increases can snowball over time, cutting into your earnings and affecting your overall performance.
What trading rules do prop firms usually enforce, and how can I follow them to avoid breaking the rules?
Prop trading firms enforce specific rules to promote disciplined trading and manage risk effectively. These often include restrictions on leverage - such as capping it at 70% - limitations on trading certain instruments, and bans on high-risk behaviors like overleveraging or trading without thorough analysis. Additionally, firms typically set boundaries like maximum drawdowns or daily loss limits to safeguard their capital.
To remain within these guidelines, it's essential to thoroughly understand the firm's rules, adhere to profit targets and risk management parameters, and ensure you don't exceed loss limits (for instance, keeping losses on a single trade below 3%). A disciplined mindset and regularly reviewing the firm's policies can help you avoid costly violations.