Proprietary trading, also known as prop trading or principal trading, is the practice of trading financial instruments or commodities as principal, using a firm's own capital rather than trading on behalf of a client. The profits and losses from the activity accrue to the firm itself, distinguishing proprietary trading from agency brokerage, asset management, and other client-account activities.
Proprietary trading is carried out by investment banks, broker-dealers, market makers, and independent principal trading firms across markets including equities, fixed income, derivatives, commodities, and the foreign exchange market. It may involve discretionary trading by individual traders, automated or algorithmic trading, statistical arbitrage, high-frequency trading, market-making inventory management, or longer-horizon directional positions. Because market-making and hedging also require a firm to hold positions on its own balance sheet, the distinction between proprietary trading, client facilitation, and risk management is often based on the purpose of the trade rather than the legal form of the transaction.
The practice became a prominent part of large-bank trading businesses in the late twentieth and early twenty-first centuries. After the 2007–2008 financial crisis, regulators in several jurisdictions restricted proprietary trading by banks or separated it from deposit-taking activities. The most prominent restriction is the Volcker Rule in the United States, which generally prohibits banking entities from proprietary trading and from sponsoring or investing in covered hedge funds and private-equity funds, subject to exemptions for underwriting, market making, risk-mitigating hedging, and other permitted activities.
Definition and scope
In regulatory usage, proprietary trading means trading as principal: the firm buys, sells, or otherwise acquires a financial instrument or commodity for its own account. The Prudential Regulation Authority has defined it as trading in financial instruments or commodities as principal, requiring the use of the firm's capital, liquidity, or both, with profits and losses accruing to the firm rather than to clients.
The term is sometimes used narrowly to refer to "classic" proprietary trading: short-term own-account trading intended to profit from changes in market prices and unrelated to customer activity. A broader definition can include market-making positions, client facilitation, liquidity management, and hedging, because these activities also involve a firm acting as principal.
Post-crisis capital, liquidity, and conduct rules reduced the attractiveness of classic proprietary trading inside large banks. In its 2020 review, the Prudential Regulation Authority reported that it had not found substantial classic proprietary trading by relevant UK-authorised banks and investment firms, partly because such activity no longer formed a material part of large financial institutions' business models and partly because post-crisis regulation had increased the capital required to support trading activities.
The growth of these firms changed market structure. Banks remained important in dealer-to-client markets, financing, settlement, and prime brokerage, while electronic proprietary firms became prominent in low-latency market making and arbitrage across exchanges and trading venues.
Retail-funded trading programmes
In consumer finance, the phrase "prop trading" is also used by retail-facing "funded trader" businesses. These programmes typically charge aspiring traders an evaluation fee and promise access to a funded account or profit share if the participant meets trading targets and risk limits. Press coverage has described many such programmes as operating through simulated accounts during the evaluation stage, with critics pointing to fees, low payout rates, and the difficulty of sustaining profitability. These retail programmes are distinct from institutional proprietary trading by banks and principal trading firms, although they use similar terminology.
Strategies
Proprietary trading strategies vary by asset class, holding period, technology, and risk appetite. Many firms combine several strategies and allocate risk capital among desks according to performance and limits.
Market making and inventory trading
Market makers quote prices at which they are willing to buy and sell an instrument. They seek to earn the bid–ask spread while managing the risk that inventory changes in value before it can be hedged or sold. In over-the-counter markets, dealer market makers also provide immediacy to clients who want to transact in size without waiting for a natural counterparty.
The Volcker Rule does not ban proprietary trading by all firms. Independent proprietary trading firms, hedge funds, and other non-bank entities may trade for their own accounts, subject to securities, commodities, market-abuse, capital, clearing, and reporting rules that apply to their activities. The rule is aimed primarily at banking entities and their affiliates because of their access to deposit insurance, the Federal Reserve discount window, and other forms of public support.
Economic role and criticism
Liquidity and price discovery
Supporters of proprietary trading and principal market making argue that firms willing to commit capital improve liquidity, narrow bid–ask spreads, and support price discovery. Market makers provide immediacy by buying when clients want to sell and selling when clients want to buy, absorbing inventory risk that might otherwise remain with end investors.
Conflicts of interest
A major criticism of proprietary trading is that it can create conflicts between a firm's own positions and the interests of its clients. Conflicts may arise when a bank trades for its own account while advising clients, executing customer orders, making markets, publishing research, or distributing securities. These concerns were central to post-crisis debates about whether deposit-taking institutions should be allowed to conduct speculative trading.
Systemic and prudential risk
For banks, proprietary trading can increase systemic risk when losses occur inside institutions that perform payment, lending, deposit-taking, or market-intermediation functions. Critics argue that public support for banking, including deposit insurance and central-bank liquidity facilities, may subsidise risk-taking and create moral hazard. The Volcker Rule and UK ring-fencing were designed in part to separate or restrict speculative trading where it could threaten essential banking functions or public backstops.