7 Prop Firm Red Flags Guide (2024 Update)

Summary

This video script discusses the hidden challenges and tricks of proprietary trading firms (prop firms) that may lead traders to fail. It highlights the importance of understanding the types of drawdowns, avoiding deceptive marketing tactics, and recognizing the potential for unfair practices like slippage and payout restrictions. The speaker emphasizes the need for traders to be wary of prop firms with unfavorable conditions, suggesting that a fair and transparent business model is crucial for success in trading.

Takeaways

• 🤔 The speaker expresses skepticism about prop firms, suggesting they may not have traders' best interests at heart due to their business model, which profits from traders' losses.
• 💡 Prop firms are seen as a tool that can provide opportunities like access to larger capital, but they may also use gamification methods to manipulate traders' emotions and psychology, leading to poor trading decisions.
• 📉 The speaker is critical of 'equity-based' and 'trailing' drawdowns, which can be unfair to traders, especially those who trade with high risk-reward ratios, as they can lead to account closures even after profitable trades.
• 📊 The importance of understanding the terms and conditions of prop firms is highlighted, as confusing language can mask unfavorable conditions that may trip up traders.
• 🚫 A warning against prop firms that impose minimum profit requirements before payouts, suggesting they may be trying to avoid paying out on small profits earned by traders.
• 💰 The speaker advises traders to be wary of marketing gimmicks and to assess the true value of a prop firm beyond just the initial cost or profit targets.
• 📈 A suggestion to use a ratio formula to compare the maximum drawdown to the total profit target to evaluate the fairness of a prop firm's challenge terms.
• 🛑 The potential issue of slippage is discussed, where some prop firms might intentionally provide poor trading conditions to cause traders to lose more money.
• ❌ A caution against choosing prop firms based on influencer endorsements or social media presence, as these can be misleading and not indicative of the firm's reliability.
• 🏢 The risks associated with prop firms that outsource their technology to third-party providers, which may lead to higher costs and potential instability.
• 📝 The speaker emphasizes the need for traders to have autonomy in their trading decisions, criticizing prop firms that restrict holding trades over weekends or during news events.

Q & A

What is the primary concern of prop firms according to the video script?

The primary concern is that prop firms make money when traders lose money, and they may use hidden tricks to ensure traders fail, which in turn lines their pockets.

What are the three types of drawdown mentioned in the script?

The three types of drawdown are balance-based drawdown, equity-based drawdown, and trailing drawdown.

Why is the balance-based drawdown considered fair by the speaker?

The balance-based drawdown is considered fair because it allows traders to lose only a certain percentage of their account balance after closed positions, which protects traders and ensures they are not trading recklessly.

How does the equity-based drawdown differ from the balance-based drawdown?

The equity-based drawdown is based on unrealized profits, meaning it can cause a trader to lose their account even if they haven't closed a losing position, and it can penalize traders for drawdowns in profit that haven't been realized yet.

What is the issue with the trailing drawdown according to the speaker?

The issue with the trailing drawdown is that it reduces the trader's buffer for losses as they make profits, which can lead to account closure even after the trader has earned a profit, and it's seen as unfair because it doesn't reflect real-life trading conditions.

What is the speaker's opinion on the use of gamification methods by prop firms?

The speaker believes that gamification methods like leaderboards and certificates are used by prop firms to emotionally manipulate traders, which negatively affects their psychology and trading strategy.

What is the ratio formula suggested by the speaker to evaluate prop firm deals?

The ratio formula suggested is total profit target divided by max drawdown, which helps to determine if a prop firm's deal is favorable or not.

Why does the speaker warn against choosing a prop firm based on low prices or profit targets?

The speaker warns that low prices or profit targets may come with hidden catches like equity-based or trailing drawdowns, large slippages, or high commissions, which can make it harder for traders to succeed.

What is the potential issue with prop firms that outsource their tech to external providers?

The potential issue is that these prop firms may have to pay a significant percentage of their revenue to the tech providers, which can lead to financial instability and the need to make traders fail more often to maintain profitability.

What are some of the red flags the speaker advises to watch out for when choosing a prop firm?

Red flags include equity-based or trailing drawdowns, minimum profit requirements for payouts, influencer promotions, and restrictions on trade holding times such as overnight or over weekends.

Why does the speaker suggest avoiding prop firms that have recently started or are promoted by influencers?

The speaker suggests avoiding these firms because they may not have a proven track record, and their promotions may be marketing gimmicks rather than indicators of a fair and sustainable business model.