With retail Forex prop trading gaining popularity, many potential traders ask themselves: what happens if you lose money on a funded account? Before answering this crucial question, I will elaborate on the difference between retail prop trading and professional prop trading, as many retail traders think they are identical. Before traders consider the fee-based challenges at retail prop trading firms, they must master risk management, as strict maximum drawdown limits pose a significant challenge to any strategy.
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How Prop Trading Works
I will explain how prop trading works at retail prop trading firms, which differs from prop traders at licensed, professional financial firms, hedge funds, and high-frequency trading firms.
Retail prop traders must understand three defining aspects before proceeding:
- They will always trade in demo accounts and never with real money
- Retail prop firms use copy trading software to copy trades from demo to live accounts they manage at their discretion
- Some retail prop traders will never have their trades copied to real money accounts
Here is how retail prop trading works:
- Managing partners provide initial trading capital
- The best retail prop firms seek profitable retail traders that lack capital
- A paid-for challenge model serves as an initial test and a massive monthly revenue stream
- Few retail traders pass the challenge and pay a monthly fee for access to capital in a demo account
- Prop firms use copy trading software and copy trades into live portfolios at their discretion
- A profit-share model provides the prop firm with ongoing capital and rewards traders with income
- Strict risk management protocols leave little room for error, and retail prop firms kick out traders as soon as they breach a tight drawdown window
Most retail prop firms claim that they earn when their prop traders earn via a profit-share model, but many retail prop firms earn most of their revenues from paid-for challenge fees and monthly subscriptions.
Here is an example:
- Prop trading firm ABC has 10,000 funded prop traders who pay $150 per month for access to capital, generating $1,500,000 in monthly non-trading revenue
- For each funded account, assume 100 traders fail the challenge, which costs $100, or 10,000 (funded traders) x 100 (failed traders per funded account) = 1,000,000 x $100 for a total of $100,000,000 in one-off non-trading revenue
Noteworthy:
- The more capital traders seek, the higher the one-off challenge fee and monthly subscription
- Restrictive trading conditions, plus tight daily loss and overall loss limits before the loss of access to capital results in traders either blowing their account or generating relatively small profits, of which the prop trading firm takes between 10% and 50%
The Challenge and the Live Phase in Prop Trading
The challenge phase:
The challenge phase is an initial test to limit risk, as retail prop firms actively seek profitable traders to copy. The conditions are unrealistic and place excessive pressure to achieve profits, often ignoring sound risk management while implementing strict daily and overall drawdown rules.
Traders pay real money for access to demo accounts, and the more capital they seek, the higher the one-off challenge fee and the monthly subscription fee for traders who pass the challenge. Reading the rules and requirements confirms it resembles a game more than trading. For example, if a trader makes the required profit in one trade, they pass the challenge. Some retail prop firms have a two-tier challenge phase, but the basics remain identical.
The live phase:
The live phase keeps traders in demo accounts, but prop firms may copy trades into live accounts at their discretion. A profit-share model exists, but some traders must trade a certain amount before qualifying for withdrawals, funded by one-off challenge fees.
Can I Lose Money in a Funded Account?
Retail prop traders will trade in demo accounts, making all profits and losses theoretical, meaning they are not liable for any losses. So, what happens if you lose money on a funded account? Traders who violate the maximum drawdown rule lose access to the account and must pay and pass the challenge again.
How Prop Firms Limit Risk
- Tendency of prop firms to keep traders in demo accounts
- Strict drawdown rules
- Restriction on overnight trading
- Limitations during news events
- Stop-loss order requirements
- Copying traders with proven track records
What Is the Maximum Drawdown Rule?
The maximum drawdown rule is a hard-loss limit, for example, 10% of the funded account balance. Once traders violate the maximum drawdown rule, they lose access to their funded account.
What to Do If I Start Losing Money in a Funded Account
- Step away from trading
- Decrease trading volumes
- Evaluate parameters of the strategy
- Add confirmation rules
- Change trading times and timeframes
Tips for the Best Prop Firm Trading Experience
- Understand the terms and conditions
- Choose a prop firm that supports algorithmic trading
- Verify their withdrawal reliability
- Avoid prop firms with restrictive trading conditions
- Trade with transparent prop firms who disclose their brokers and partners
Bottom Line
What happens if you lose money on a funded account? Since retail prop trading firms keep traders in demo accounts, the only thing that happens is that traders lose access to funded demo accounts if they violate the maximum drawdown level.
