A NYT article Day Trading In China a Growing Business, describes a prop trading opportunity for young Chinese men and their payout.
“If the traders make a profit, they keep between 10 and 50 percent, with the rest split between the trading firm and the investor. (If the traders produce a loss, they risk the firms’ clients and possibly their own jobs.)”
John C. Coffee Jr., a securities law expert at Columbia University, says the arrangement amounts to a huge and odd brokerage fee.
“It’s extraordinarily high compensation. If this were happening in the U.S., the fees would be excessive,” he said in a telephone interview. He added that even if the traders could outperform the overall market, “The transaction fees would eat up some of the gains.”
I disagree with Professor Coffee. If you trade for a hedge fund, for example, there usually is an 80/20 split with the client. Of the 20% that the firm receives as the incentive fee or profit allocation, a trader with experience can earn 50% of that, or what equates to 10% of the profits they generate on their trading capital.
If you trade for a prop firm there is a very similar payout.
If you get a job at Merrill Lynch or Smith Barney, how much of your commissions and fees do you think you get to keep at the end of each month? Depending on your overall level of production and assets under management, you’re looking at somewhere between 20 and 50% before taxes and deductions. The latter would be for very large producers. And in the case of prop traders, they are producing absolute returns, not relative returns. A financial advisor in the US can make a few hundred thousand by losing clients money.
It is enormously expensive to run a prop trading firm in a large city, however, I do think that 10% is a little low. It’s not clear what comprises that payout. It might be for the first few months of trading so that the prop firm can recoup some of its training costs.
Professor Coffee may have forgotten the enormous amount of resources that go into training new traders:rent, the utilities, the technology, and the rate of return that has to be paid to the backers. (Not every firm has backers, some just have their own capital).
All in, it’s quite a great thing to get hired at a prop trading firm, have a desk waiting, have expert training, and most importantly, have an allocation of trading capital. Everyone wants to shoot the gun, but no one wants to get the bullets.
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