Saturday, January 30, 2010

Should Proprietary Trading Firms Charge for Their Education?

I notice that several readers have commented upon my recent post that quoted SMB Trading's Bella. The comments concerned the fees that SMB (and other firms) charge for their training programs. This, to some, smacks of a scam.

So allow me to wade into a contentious area, one that has been hotly debated on some online forums:

I think the model in which prop firms charge a training fee before a trader can join the firm is fraught with potential problems. How it is implemented makes all the difference in the world.

As I note in this post and in this one, very high education fees may be a sign that this is actually the way that the "prop firm" is making its money. When this is the case, the firm will have five-figure fees as a rule and will allocate very, very small trading size to traders. The firm will also charge traders high commission rates. If the trader hits a certain loss limit (and the vast majority will because of the small size and high commissions), the trader will either lose their "job" or will be asked to advance more capital.

This, in my opinion, is an outright scam. There *is* no prop firm, only the illusion of one to lure newbie traders into educational programs. Very often, these efforts at education are quite thin, consisting of nothing more than the kind of garden-variety technical analysis you could pick up in any trading text. There are no skills building efforts through simulators, no substantive mentorship. Often, these watered down programs are offered to traders who trade remotely (i.e., from their home locations). That's actually a warning sign: true prop firms value teamwork, hands-on mentorship, and trading technology; it's tough to sustain those when traders are remote.

Another warning sign, ironically, is that the less-than-legitimate firms will feature unusually high payout ratios, allowing traders to keep almost all of their profits. That means that the firm is not counting on trader profitability for their own profits, and it usually means that the firm is not firmly committed to trader profits. Rather, fees and commissions are what the firm is after. The trader is a customer of such a firm, not an employee.

If you want to join a prop firm, you should be able to see the trading floor, interact with the traders, and see first hand who is making their living from their trading. If the kimono isn't open to that degree, beware.

OK, that having been said, let me take the other side of the argument:

I have no problem with firms charging a fair fee for their educational efforts. This is particularly the case when the firm is offering the education as a stand-alone offering. There are very few prop firms that make their training available to outside traders. For instance, it's very difficult to find credible educational programs on reading order flow (tape reading). The program at SMB is available at a fee for those who aren't affiliated with the firm. Traders can assess the fee and the content of the program and decide if it's a fair deal.

As a rule, if the educational offerings have a structured curriculum, opportunities for skills building (and not just information), and last for weeks or months (not just days), they have the potential to move traders' learning curves forward. I am not a fan of brief training programs, as they simply lack the time to develop skills.

When a trader is required to go through the educational program (at a fee) to join the firm as a prop trader, it's important to view the firm as two separate companies. The first company is the education provider; the second is the trading firm. It is possible that you could like the company for its education, but not for its actual trading--or vice versa. By separating out the education from the prop opportunity, you can evaluate each on its own merits.

Personally, I would view the opportunity to trade for the firm as an out-of-the- money call option. In other words, if they like me and I like them and I do well in the program, I may get a large payoff by joining the firm. But I'm going to go into the education with the idea that the option may expire worthless. I might not like the firm, they might not like me, and my trading style ultimately may not fit theirs.

Once I have that mindset, I can ask myself: would I pay the fee for the education, even if it doesn't lead to an offer to join the firm? If the answer is no, I say move on. If the answer is yes and you also like the frosting on the cake of the call option, then it makes sense to pursue the training. But no trader, in my opinion, should "pay to play". The training has to stand on its own as a career and economic value.

All of this means that joining a prop firm requires considerable due diligence. There are real scams out there, and there are honorable firms that offer a teamwork, learning-based culture and solid training. Just make sure that the firm is selling you real training, not just hopes, dreams, and fantasies. The posts below should be helpful in making the distinction.