Behind the Scenes: How Prop Firms Really Make Money

                        Video Transcript:

Hello everyone, it’s Sterling here from Trader Dale, back with another video in this prop firm series. In this one, we’re going to cover how prop firms make money. This is a question we get asked a lot—what’s in it for them? How do they make money, and what does that process look like?

In general, the primary source of income for a prop firm is the cost of the challenge and people failing those challenges. When traders fail or lose their challenges—and then reset their accounts—that generates the majority of income for a prop firm. Simply put, they make money from losing traders if we simplify it as much as possible. When traders lose, all that money goes to the firm.

For example, with Topstep, you might pay $149 for a $150,000 account, or $49 for a $50,000 account. Let’s say you choose the $150,000 account and pay $149 to activate it. Once you pass the challenge, there’s another $149 fee. If you then wipe out that account, the $300 total you paid goes directly to the prop firm—they spent nothing, and that’s their profit. Some people spend thousands of dollars on account resets every month.

It’s a valuable business for these firms because most traders behave recklessly, thinking they can just hit the buy and sell buttons and make money. The firms profit because most traders don’t treat this like a profession. As a result, most traders lose money, and firms “B-book” everyone to start.

B-booking is simple. If you buy, the firm sells to you, meaning your order never goes to the live market. Even when you pass a funded account challenge, your trades aren’t placed in the live market. For instance, if you buy one contract of the NQ, nothing is purchased in the live market—the firm sells it to you and takes the other side of the position.

If your trade is profitable, the money comes from the firm’s bank account. If your trade is a loss, the money goes to their bank account. This is why they B-book everyone initially—because most traders are losing traders.

For the small percentage of profitable traders (around 5%), the firm transitions them to an “A-book.” An A-book means the firm hedges profitable traders’ positions in the live market or through internal client matching.

For instance, if a trader demonstrates profitability, the firm will recognize their consistent performance and “A-book” them. This means the firm may hedge the trader’s positions internally against other client orders or match them with other clients. For example, if one client buys and another sells, the firm matches these trades internally without going to the live market, saving on commissions and other costs.

When internal client matching isn’t sufficient—such as when there’s a large imbalance on one side (e.g., most clients are long or short)—the firm goes to the live market to hedge.

Let’s say clients are collectively long 754 contracts on the NQ. If the market moves up, the clients make money, but the firm loses because it is effectively short that same amount. To hedge, the firm goes to the live market and buys 754 contracts to match the client positions. This offsets the firm’s risk because, as the market moves up, the losses on the client positions are balanced by gains in the live market hedge.

However, hedging isn’t perfect. Slippage, commissions, and market movement can still result in small profits or losses. To cover this, prop firms typically retain 10–20% of profits from successful traders (e.g., paying out 80–90%). This margin helps them stay profitable or at least break even on their profitable traders.

Prop firms are masters of risk management. Their biggest risk is profitable traders, so they mitigate this by quickly identifying them, transitioning them to the A-book, and hedging their aggregate risk. They don’t aim for large profits from these traders but instead focus on consistent, steady growth.

Some firms also generate additional profit by analyzing the overall trading behavior of their clients. For instance, they might identify biases in losing traders and take positions based on those discrepancies rather than directly copying profitable traders’ trades, which can incur slippage and other inefficiencies.

Some traders worry about prop firms “trading against them.” However, a good prop firm provides a fair trading environment. Their goal is to manage risk while allowing traders to succeed. As a trader, your focus should be on improving your own trading—avoiding revenge trading, over-trading, or impulsive decisions—not on whether the firm is hedging your trades.

Let’s revisit the earlier example of 754 contracts long on the NQ. If the market goes up, clients make money, and the firm loses money. To hedge, the firm buys 754 contracts in the live market. This creates a neutral position—losses to the clients are offset by gains in the live market hedge. There’s still some slippage and cost involved, but this is how firms manage risk.

In summary, the vast majority of prop firm income comes from challenge fees and account resets, as most traders lose. For profitable traders, firms transition them from B-book to A-book, using internal client matching and live market hedging to manage risk. They aim for consistent growth rather than high-risk profits, ensuring their long-term sustainability.

If you’re interested in becoming a profitable prop firm trader, check out the Funded Trader Academy. This program allows you to work directly with Dale and our team of funded traders. You’ll participate in live trading sessions, receive video feedback, and get one-on-one support to help you succeed.

Thanks for watching, and I’ll see you in the next video!