Proprietary Trading

Proprietary trading (also "prop trading") occurs when a trader trades , bonds, currencies, commodities, their derivatives, or other financial instruments with the firm's own money, as opposed to depositors' money, so as to make a profit for itself. Proprietary traders may use a variety of strategies such as index arbitrage, statistical arbitrage, merger arbitrage, fundamental analysis, volatility arbitrage or global macro trading, much like a hedge fund. Many reporters and analysts believe that large banks purposely leave ambiguous the proportion of proprietary versus non-proprietary trading, because it is felt that proprietary trading is riskier and results in more volatile profits.

Banks are companies that assist other companies in raising financial capital, transacting foreign currency exchange, and managing financial risks. Trading has historically been associated with large banks, because they are often required to make a market to facilitate the services they provide (e.g., trading stocks, bonds, and loans in capital raising; trading currencies to help with international business transactions; and trading interest rates, commodities, and their derivatives to help companies manage risks).

For example, if General Store Co. sold stock with a bank, whoever first bought shares would possibly have a hard time selling them to other individuals if people are not familiar with the company. The investment bank agrees to buy the shares sold and look for a buyer. This provides liquidity to the markets. The bank normally does not care about the fundamental, intrinsic value of the shares, but only that it can sell them at a slightly higher price than it could buy them. To do this, an investment bank employs traders. Over time these traders began to devise different strategies within this system to earn even more profit independent of providing client liquidity, and this is how proprietary trading was born.

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