How Prop Firms Make Money
Prop trading firms, or proprietary trading firms, have become increasingly popular as more traders seek opportunities to trade with large amounts of capital. However, the way these firms make money can vary significantly depending on their business model.
In general, modern prop firms profit by selling challenges to aspiring traders and keeping a large portion of the revenue generated by traders who fail.
This article explores how prop firms operate, their business models, and the differences between “A Book” and “B Book” prop firms.
The Concept of 98% to 2%
One of the most important elements to understanding how prop firms make money is recognizing the success rate of traders who engage in their programs. Statistically, about 98% of traders fail to pass the trading challenges or maintain consistent profitability. Prop firms typically offer various “challenges” that require traders to prove their skill by achieving specific profit targets without exceeding predefined risk limits. To enter these challenges, traders must pay a fee.
For the vast majority—approximately 98%—these fees represent sunk costs, as they fail the challenge and are not refunded. This high failure rate forms a significant revenue stream for the firm. The remaining 2% of traders who are able to pass the challenge and demonstrate consistent profitability are given access to large trading accounts.
While these top-performing traders are entitled to a share of the profits they generate, the overall business model of the firm ensures that the profits from these successful traders are a fraction of the revenue collected from the 98% who do not make it.
A Book vs. B Book Prop Trading Firms
To fully understand how prop firms make money, it’s essential to distinguish between A Book and B Book firms.
- A Book Prop Trading Firms:
These firms operate by trading real money in the market. When traders with the firm place trades, the firm actually mirrors or executes those trades using real capital. A Book firms typically operate more like traditional asset management companies, where both the firm and the trader are directly exposed to the risks and rewards of the market. Their profit is tied to the success of their traders, which means the firm is highly selective about which traders it funds, as it has real capital at risk. - B Book Prop Trading Firms:
Most modern prop firms fall into the B Book category. These firms do not actually place trades in the real market. Instead, they simulate the trading experience for their traders. In a B Book model, the trades that a trader places are never executed with actual capital. Rather, they exist on a simulated or internal platform. The firm’s profit in this case does not come from the success of traders but from the difference between the fees collected from challenge participants and the payouts made to the 2% of successful traders. Because the firm does not place trades in the real market, it is insulated from market volatility and losses. Their main source of revenue is the fees from unsuccessful traders.
The Business Model of Prop Trading Firms
The business model of modern prop firms, especially B Book firms, revolves around managing risk and maximizing the gap between the revenue generated from failed traders and the profits they share with the successful few. Let’s break down their revenue streams and cost structure:
1. Revenue Streams:
- Challenge Fees:
The most significant revenue source for these firms is the entry fee charged to traders attempting to pass the firm’s challenge. These challenges require traders to achieve specific profit targets under strict risk parameters. Since the majority (98%) fail to meet these criteria, the firm retains their fees. - Platform Fees:
In some cases, firms may charge additional fees for access to proprietary trading platforms or ongoing account management.
2. Cost Structure:
- Payouts to Successful Traders:
The firm must share profits with the 2% of traders who pass the challenge and continue to trade profitably. These payouts can be a significant expense but are generally offset by the large pool of failed challenge fees. - Marketing and Acquisition Costs:
Prop firms invest heavily in marketing to attract new traders to take their challenges. This may include online advertising, influencer partnerships, and offering affiliate programs. By maintaining a strong flow of new entrants, the firm ensures a steady income from challenge fees. - Operational Expenses:
This includes maintaining the platform, customer support, and compliance with regulations. However, since B Book firms don’t trade real money, they avoid many of the costs associated with market exposure, such as transaction fees and potential trading losses.
The Math Behind Prop Firms
Understanding the math behind prop firms is key to seeing why they’re structured the way they are, and why most traders fail. Prop firms thrive on a business model that plays with traders’ emotions and leverages their mistakes. While these firms offer an excellent opportunity for those who don’t have the capital to trade, the statistics reveal that only a small percentage of individuals succeed.
Let’s break down the numbers.
Take Apex Trader as an example, one of the more transparent firms. In a recent month, 15,000 accounts reached funded status. To get there, traders pay an average of $35 for a $50K evaluation account and $150 for a funded account fee. This means Apex Trader pulled in at least $2.7 million in that month from evaluations and funded fees alone, without even accounting for failed evaluations or the recurring monthly fees some traders pay.
What’s surprising is the payout data. Apex claims to pay out an average of $940,000 per month. If we divide that by the 15,000 funded accounts from last month, the average payout per funded account is $63. This number is high, considering that payouts also include accounts from previous months, so the actual average per funded trader is likely even lower. This tells us that most traders blow their accounts quickly, while a small number of successful traders are reaping the rewards.
Why Most Traders Fail
The math shows that the majority of traders who pass the challenge struggle to maintain profitability. This is because prop firms give traders access to large amounts of capital—often much more than they’ve ever managed on their own. This abundance can lead to emotional trading, where traders over-leverage and take on excessive risk, ultimately blowing their accounts.
Prop firms are not inherently designed to make traders fail, but their structure makes it easy for undisciplined traders to fall into these traps. The challenge and capital size are set up in a way that rewards careful, strategic trading, but punishes emotional or impulsive decisions.
The Role of Personal Responsibility
It’s easy to blame prop firms for individual failure, but the reality is that traders are responsible for managing their risk. The access to large capital provided by prop firms isn’t meant to trick traders into over-leveraging; rather, it’s an opportunity to trade with more resources. Success depends on maintaining discipline, managing risk, and sticking to a sound strategy.
Many traders fail because they let greed or overconfidence take over, and they make poor decisions that lead to losses. The harsh truth is that success in prop trading is reserved for those who can control their emotions, manage risk effectively, and stay disciplined. The failure of the majority is not a reflection of a flawed system, but rather the reality that many traders aren’t prepared to handle the pressures of managing large sums of capital.
Conclusion: The Numbers Don’t Lie
The math behind prop firms shows that they are designed to be profitable for the firm by relying on the fact that most traders won’t succeed. However, for the 2% who do, these firms provide an incredible opportunity to scale up trading. The key is understanding how to manage risk, control emotions, and avoid the pitfalls of over-leveraging. With the right strategy, including techniques like the trade copier, traders can maximize their chances of staying profitable and become part of that elite group.
The Psychology of the Prop Firm Business Model
Modern prop firms also exploit psychological factors. Many aspiring traders are drawn to the idea of managing large accounts and earning substantial profits, and the relatively low cost of entry (compared to self-funding a large trading account) creates a high level of appeal. The challenge structure, with strict rules and conditions, is often designed to be difficult to pass, increasing the likelihood of traders failing.
Additionally, the prospect of becoming part of the elite 2% who succeed serves as a strong motivator for repeat attempts. This generates repeat business from traders who continually try to pass the challenges, contributing further to the firm’s revenue.
The Future of Prop Firms
The prop firm industry is evolving rapidly, especially with advancements in trading technology and the rise of retail traders. In the future, we may see more transparency regarding the operations of these firms, especially as regulators begin to scrutinize the B Book model more closely. As the landscape shifts, new business models may emerge, such as hybrid firms that combine elements of A Book and B Book models or firms that provide more realistic opportunities for traders to grow. FTMO is moving in this direction with the acquisition of Quantlane.
In summary, modern prop firms, particularly those using the B Book model, profit primarily from the fees of the 98% of traders who fail their challenges. By focusing on marketing, minimizing risk, and paying out only a small percentage to successful traders, these firms have built a lucrative business model. Whether or not this model will continue to thrive depends largely on the growing interest in trading and how the regulatory environment adapts to these innovative practices.
Key Takeaway for you as a trader
The most important thing for traders is to focus on being part of the 2% who consistently make profits. Whether it’s through skill development, disciplined risk management, or strategic planning, the ultimate goal is to pass the challenges and stay profitable.
Once you’re in that elite group, it doesn’t matter how prop firms operate—what matters is your ability to earn and maximize your trading success.