When prospective traders buy a challenge account from a prop firm, they’re often enticed by the dream of becoming a successful "funded" trader, earning millions just like in the movies. They picture themselves as the next Gordon Gekko or Jordan Belfort. But in reality, few achieve that success. Why?

First, very few traders actually pass the challenges. While prop firms aren’t obligated to publish success rates, estimates suggest that fewer than 5% of traders ever make it through.

Second, even when a trader does pass and gets “funded,” what happens next is where the real issues begin.

At a recent industry conference, the co-founder and CEO of one of the largest prop firms admitted that most of their trades go to the "B-book"—meaning the trades are never placed in the real market. Essentially, these traders are dealing with virtual funds, and the firm is betting that they will eventually lose all the money in their account. In most cases, that's exactly what happens.

This practice isn’t unique to one firm. Many prop firms rely on the failure of traders to stay profitable, and even for the small percentage who do pass the challenge and get funded, the firm anticipates that they will lose in the long run.

What Happens When a Trader is Profitable?

Even when traders are successful, it doesn’t always guarantee a payout. Many firms closely review every aspect of the trader’s performance before approving withdrawals, often finding minor rule violations that allow them to withhold payments. In an unregulated industry, where firms set their own rules, this has become a common practice.

The barriers to entry in the prop trading industry are extremely low. Firms don’t need significant capital, nor do they have to place any real trades in the market. This has led to a surge in new firms entering the space, often operating with unsustainable models.

So, if a trader does pass the challenge, follows all the rules, and makes a profit, how does the firm pay them if no real profits were generated? The answer: with money from new traders entering the system.

Does This Sound Like a Ponzi Scheme?

As competition among prop firms grows, many are relaxing their rules to attract more traders. But this also increases the risk that firms won’t be able to fulfill their obligations to profitable traders, especially if they’re not generating real market returns.

How Can You Protect Yourself as a Trader?

The best way to protect yourself is to choose prop firms that are regulated. Firms with CFD broker-dealer licenses have been vetted by regulators, their accounts are audited, and they often offer investor compensation schemes to guarantee payouts.

However, if regulated firms aren’t an option, here are a few key criteria to look for:

1. Transparency: Select firms that publish the percentage of traders who pass their challenges. While these figures aren’t always audited, transparency is a good sign.
2. A-Book Trading: Choose firms that “A-book” funded account trades. This means that once a trader is funded, the firm executes and covers their trades in the actual market, not just on a virtual ledger.
3. Experienced Management: Look for firms where management is easy to locate and has experience in running financial institutions. This adds credibility and reduces the likelihood of unethical practices.
4. Liquidity Providers: Ensure the firm has access to one or more liquidity providers, which allows them to execute real trades and manage risk effectively.

While none of these factors are foolproof, they significantly reduce the risk of your hard-earned profits vanishing without a trace.

‍