How to Handle Risk and Loss in Prop Trading

Jeremy BiberdorfBy: Jeremy Biberdorf

June 7, 2023June 7, 2023

In the intricate and diverse world of financial markets, proprietary trading, or ‘prop trading‘ as it’s commonly known, stands out as a compelling domain. Proprietary traders, who work for hedge funds or proprietary trading firms, trade with the firm’s capital rather than client funds. This creates a unique risk and reward dynamic, offering high potential profits but also risking significant losses.

Whether you’re a retail trader considering a transition into prop trading or an experienced trader seeking to sharpen your skills, understanding how to handle risk and loss is an essential aspect of this field. Let’s dive deeper into the strategies successful traders use to navigate these challenges and reach their profit targets.

Understanding Trading Risk

In any form of trading, risk is an inherent component. Trading risk refers to the potential for financial loss inherent in a trading activity. Day trading, for example, involves risk due to market fluctuations. In prop trading, this risk is compounded by the high stakes involved.

Prop traders must take calculated risks based on a range of factors, including market conditions, their trading skills, and the capacity of their trading platform. The potential for loss is ever-present, but skilled traders develop strategies to manage this risk.

Risk Management in Prop Trading

In proprietary trading firms, one of the primary ways risk is managed is through setting a ‘Profit Target.’ This is an amount that prop traders aim to earn over a set period. Once a trader reaches their profit target, they can take a portion of these earnings — a ‘profit share’ — as their compensation.

Prop firms often use a method known as ‘merger arbitrage’ to reduce risk. This involves buying and selling the stocks of two merging companies to take advantage of price discrepancies. Similarly, ‘volatility arbitrage’ strategies seek to profit from price differences created by market volatility.

Another strategy is to diversify the types of trades made. Some prop firms are ‘forex prop firms,’ specializing in foreign exchange markets, while others may focus on a mix of trading styles such as macro trading, news trading, and more.

These firms also have an evaluation process to assess their traders’ performance. This typically involves a two-phase evaluation period where the firm assesses the trader’s ability to meet profit targets while managing risk.

Handling Loss in Prop Trading

Even with the best risk management strategies in place, losses are an inevitable part of trading. An important aspect of a trader’s skillset is the ability to handle these losses professionally.

Successful traders understand that loss is part of the process. They approach it as a learning opportunity, using it to refine their trading strategies and improve their trading skills.

The Role of Prop Trading Firms

Many prop traders work within proprietary trading firms. These firms provide a supportive environment for both beginner and expert traders to develop their skills and become more successful.

Some prop trading companies, such as City Traders Imperium, offer a unique ‘Relaxed Trading Rules’ approach. This approach allows traders to adopt a trading style that suits them best, rather than adhering strictly to one strategy.

Many firms also provide proprietary trading software to help traders analyze market data and execute trades more efficiently. The use of advanced trading software is becoming increasingly crucial in the fast-paced world of prop trading. Wondering what you need to consider when choosing a prop trading firm, click here.

Click here to check out our list of top prop trading firms.

Becoming a Successful Prop Trader

Prop trading requires a balance of knowledge, skill, and resilience. Building your trading experience is key, but so is maintaining a positive mindset in the face of losses.

Education also plays a crucial role in your development as a prop trader. For instance, understanding the legal and regulatory aspects of prop trading.

Simultaneously, knowledge of quantitative analysis can enhance your decision-making abilities and increase your chances of meeting your profit target.

To become a successful trader, it’s important to remember that every trader — beginner or professional — experiences loss. What sets successful traders apart is their ability to learn from these losses and continue improving their trading skills.

Becoming a skillful trader in the prop trading world is not solely about maximizing profits. It’s about consistently making informed decisions, managing risks effectively, and maintaining a healthy mindset that embraces loss as part of the journey towards financial independence.

Strategies for Mitigating Trading Loss

While prop traders cannot entirely eliminate the possibility of losses, there are several proven strategies to mitigate them. Successful traders typically employ a combination of these methods to manage their risks effectively.

Setting a Stop Loss

One of the most common and crucial risk management tools in trading is the stop loss. This strategy involves setting a predefined point where a trader exits a position if the market moves against them, preventing further losses. Effective use of stop loss requires a clear understanding of market trends and volatility.

Position Sizing

Experienced traders understand the importance of position sizing – determining the amount of capital to invest in a specific trade. By managing the size of their positions, traders can limit the potential losses from any single trade, ensuring that they do not jeopardize their entire portfolio.


Diversification is a risk management strategy that involves spreading investments across various financial instruments or sectors to reduce exposure to any single asset or risk. In the context of prop trading, this could involve trading in different asset classes, such as equities, bonds, commodities, and currencies.

Regular Evaluation and Adjustment

Successful traders consistently evaluate and adjust their trading strategies based on market conditions and performance. This involves a continuous learning process, where traders analyze their successful and unsuccessful trades to identify patterns and improve their strategies.

Mental and Emotional Resilience

Successful prop trading requires a high degree of mental and emotional resilience. Losses can be stressful and demoralizing, but maintaining a disciplined and rational approach is crucial.

Traders should avoid becoming overly attached to any single trade and learn to accept losses as an integral part of the trading journey.

The ultimate goal of prop trading isn’t just to avoid loss; it’s to achieve consistent profits over the long term.

Utilizing a Trading Journal

Another key aspect of prop trading that supports mental and emotional resilience is the disciplined use of a trading journal. Keeping a comprehensive trading journal allows traders to record their trades, strategies, thoughts, and emotions in real time.

Not only does this journal act as a record of trading activity, but it also provides valuable insights into patterns and trends within your trading behavior. By analyzing this information, traders can identify their strengths and weaknesses, understand the emotional triggers influencing their trading decisions, and track their progress towards their financial goals. It’s an instrumental tool in becoming a self-aware and skillful trader.

A trading journal like TraderSync goes a step beyond just record keeping. It provides analytics and reporting tools to help you make sense of your trading data. You can analyze your trading patterns, identify profitable trades, and highlight areas where you need to improve.

It’s a valuable resource to not just record your trading journey, but learn from it and evolve as a trader.

Take control of your trading journey and leverage the power of insights from your own trading activity. Read our TraderSync review today to discover how this tool can transform your trading strategy and help you reach your financial goals.

Jeremy Biberdorf
Jeremy Biberdorf

About the Author:

Jeremy Biberdorf is the founder of Modest Money. He's a father of 2 beautiful girls, a dog owner, a long-time online entrepreneur and an investing enthusiast.

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