Prop Trading vs. Hedge Funds

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Contributor, Benzinga
February 20, 2024

Are you an investor who is trying to understand which is better in the battle of prop trading vs. hedge funds? Before answering the question, let's first understand more about these two investment trading strategies.

Both prop trading and hedge funds involve active trading in the financial markets, but they differ in terms of capital sources, regulatory requirements, and investment strategies. Prop trading is more focused on using the firm's capital to generate profits through trading activities, while hedge funds manage investor funds to deliver attractive returns.

Understanding the distinctions between prop trading and hedge funds can help you make informed decisions when considering various investment opportunities in the financial markets.

What is Prop Trading?

Prop trading, which stands for proprietary trading, occurs when a financial institution uses the firm’s capital to generate profits. It allows traders to invest in a variety of different assets such as currencies, stocks and bonds. Proprietary trading includes risk and is subject to rules and regulations.

Experienced traders make speculative trades in a prop trading account that’s related to a brokerage or hedge fund. Prop trading firms allow knowledgeable traders to access significantly larger amounts of capital for trading-related purposes. To make a profit, traders usually take a portion of the commission from successful trades.

What is a Hedge Fund?

Hedge fund managers participate in a wide range of strategies to create profit for clients, including trading with leverage. They need to keep clients happy, which hamstrings them a bit more than prop traders who need to satisfy the company’s profit targets. Hedge funds are actively managed and pool funds from investors to make a profit.

Hedge funds carry risk, and if you invest in them you place trust in hedge fund managers. The best hedge fund managers create a strong reputation to build trust and capability with investors.

Differences Between Hedge Funds and Prop Trading

Hedge funds and prop trading function in fundamentally different ways. Some of the main differences between them are

Capital Funds

Prop trading firms provide the capital necessary for traders to invest. In contrast, hedge funds obtain funds from a wide variety of sources such as private investors, corporations and other third parties.

Varied Fees

Hedge funds follow a “two and twenty” fee structure — a 2% charge for assets under management in combination with a 20% performance fee. To remain competitive, many hedge funds have lowered or changed their fee structures.

On the contrary, prop firms function using a different structure and split the profit made by traders. For example, prop firms take a portion of the profits made by a trader in combination with charging initial application fees and deposit charges.

Accountability Structures

Hedge funds are more accountable to clients because they use client money and third-party sources to make trades. In contrast, prop trading firms provide traders with the firm’s capital to make trades. Prop trading shifts the accountability structure by providing traders with capital.

In addition to investor accountability, the regulations that prop trading firms and hedge funds follow differ. For example, prop trading firms experience less regulation than hedge funds.

Risk Differences

In terms of risk, proprietary trading comes with a higher risk because traders are using the firm’s capital to trade. It’s common for prop trading firms to engage in riskier behavior such as using leverage and investing in options. Although hedge funds also engage in riskier investments, they actively engage in risk management to protect the fund and investors.

Similarities Between Prop Trading and Hedge Funds

Prop trading and hedge funds use similar strategies and strive to mitigate risk. A few similarities between them include

Goal to Create Profit

The key reason for the existence of prop trading and hedge funds is to make a profit. The two use different funding strategies but ultimately aim to increase their financial positions. To encourage profits, prop trading firms and hedge funds have created more attractive incentive plans while lowering trading-related fees.

Use Similar Strategies

Within the realm of investment funds, prop trading firms and hedge funds can use similar strategies and tools.

Strive to Mitigate Risk

Trading firms and hedge funds invest time and resources into mitigating risks. Risk mitigation can come in the form of setting guidelines and regulations or encouraging diversification. To decrease risk, prop trading firms and hedge funds strive to provide information and trading tools.

Compare Top Hedge Funds and Prop Trading Firms

Benzinga offers helpful insight that explores top hedge funds and prop trading firms. Before working with a top company, compare the benefits and drawbacks associated with each investing model.

An Investment Strategy to Meet Your Financial Goals

Overall, prop trading and hedge funds both involve a variety of strategies to make money. Prop trading is an investment vehicle that focuses on short-term gains and typically uses leverage to maximize profits. Hedge funds, on the other hand, may employ a wide array of strategies that seek to generate long-term returns.

Prop traders take risks by trying to outsmart the stock market in a short period of time, while hedge fund managers may take a more long-term view and be willing to wait out market cycles. Prop trading can be very lucrative, but the risks associated with it are also quite high. Hedge funds have lower risk levels, but may not provide the same potential for quick profits as prop trading.

Ultimately, both trading strategies offer unique opportunities for investors, who should carefully consider their goals and objectives before deciding which is best for their needs.

Frequently Asked Questions


Is a prop trading firm a hedge fund?


Prop trading firms and hedge funds function in fundamentally different ways. For example, prop trading firms usually do not answer directly to clients because they provide traders with the capital necessary for investments. In contrast, hedge funds do tend to answer to clients because they pool funds from investors to make investments. Hedge funds can perform prop trading.



Is trading for a prop firm worth it?


Yes, trading for a prop firm can be worth it. However, like any form of investing, it comes with advantages and disadvantages.



Is prop trading a good career?


Proprietary trading has the potential to generate high profits, but the amount of money that can be made depends on factors such as the trader’s level of skill, the size of their trading account, the strategies used, and market volatility.