Saturday, January 30, 2010

Should Proprietary Trading Firms Charge for Their Education?

I notice that several readers have commented upon my recent post that quoted SMB Trading's Bella. The comments concerned the fees that SMB (and other firms) charge for their training programs. This, to some, smacks of a scam.

So allow me to wade into a contentious area, one that has been hotly debated on some online forums:

I think the model in which prop firms charge a training fee before a trader can join the firm is fraught with potential problems. How it is implemented makes all the difference in the world.

As I note in this post and in this one, very high education fees may be a sign that this is actually the way that the "prop firm" is making its money. When this is the case, the firm will have five-figure fees as a rule and will allocate very, very small trading size to traders. The firm will also charge traders high commission rates. If the trader hits a certain loss limit (and the vast majority will because of the small size and high commissions), the trader will either lose their "job" or will be asked to advance more capital.

This, in my opinion, is an outright scam. There *is* no prop firm, only the illusion of one to lure newbie traders into educational programs. Very often, these efforts at education are quite thin, consisting of nothing more than the kind of garden-variety technical analysis you could pick up in any trading text. There are no skills building efforts through simulators, no substantive mentorship. Often, these watered down programs are offered to traders who trade remotely (i.e., from their home locations). That's actually a warning sign: true prop firms value teamwork, hands-on mentorship, and trading technology; it's tough to sustain those when traders are remote.

Another warning sign, ironically, is that the less-than-legitimate firms will feature unusually high payout ratios, allowing traders to keep almost all of their profits. That means that the firm is not counting on trader profitability for their own profits, and it usually means that the firm is not firmly committed to trader profits. Rather, fees and commissions are what the firm is after. The trader is a customer of such a firm, not an employee.

If you want to join a prop firm, you should be able to see the trading floor, interact with the traders, and see first hand who is making their living from their trading. If the kimono isn't open to that degree, beware.

OK, that having been said, let me take the other side of the argument:

I have no problem with firms charging a fair fee for their educational efforts. This is particularly the case when the firm is offering the education as a stand-alone offering. There are very few prop firms that make their training available to outside traders. For instance, it's very difficult to find credible educational programs on reading order flow (tape reading). The program at SMB is available at a fee for those who aren't affiliated with the firm. Traders can assess the fee and the content of the program and decide if it's a fair deal.

As a rule, if the educational offerings have a structured curriculum, opportunities for skills building (and not just information), and last for weeks or months (not just days), they have the potential to move traders' learning curves forward. I am not a fan of brief training programs, as they simply lack the time to develop skills.

When a trader is required to go through the educational program (at a fee) to join the firm as a prop trader, it's important to view the firm as two separate companies. The first company is the education provider; the second is the trading firm. It is possible that you could like the company for its education, but not for its actual trading--or vice versa. By separating out the education from the prop opportunity, you can evaluate each on its own merits.

Personally, I would view the opportunity to trade for the firm as an out-of-the- money call option. In other words, if they like me and I like them and I do well in the program, I may get a large payoff by joining the firm. But I'm going to go into the education with the idea that the option may expire worthless. I might not like the firm, they might not like me, and my trading style ultimately may not fit theirs.

Once I have that mindset, I can ask myself: would I pay the fee for the education, even if it doesn't lead to an offer to join the firm? If the answer is no, I say move on. If the answer is yes and you also like the frosting on the cake of the call option, then it makes sense to pursue the training. But no trader, in my opinion, should "pay to play". The training has to stand on its own as a career and economic value.

All of this means that joining a prop firm requires considerable due diligence. There are real scams out there, and there are honorable firms that offer a teamwork, learning-based culture and solid training. Just make sure that the firm is selling you real training, not just hopes, dreams, and fantasies. The posts below should be helpful in making the distinction.



Tony said...

Hi Brett,i must say that you are unique warrior in this Battlefield.For some of us, you're the light in this endless labyrinth, full of "endless labyrinths"....T.

Adam said...

I'd like to make this as unambiguous as possible:

I would never take a "job" that charges for training, and I recommend that you do not either. Why? Because if you are paying the entrepreneur's cost (risk) of training new hires it is not a job, it is a scam.

It is irrelevant to me that decent, intelligent people ~ such as the man whose blog this is ~ or supposedly reputable business owners (ha) claim otherwise, or that people in "the industry" say, "This is the way it has always been done."

As a serial entrepreneur who has shouldered the risks and earned the rewards (or paid the costs) entailed in starting and running businesses (both successes and flops), I know that one inescapable risk of doing business is personnel.

Finding, hiring, training, supervising, retraining, nurturing, retraining, compensating, retraining, directing, retraining, ad infinitum (are you beginning to see a pattern?), quality, motivated individuals and teams is hard. It's also expensive.

It's also a normal cost of doing business in any legitimate business.

When a business owner outsources normal costs of doing business, they are no longer in the business they claim they are in. The "employee" paying for training is not an employee, but a customer: a customer who can and will be "fired" when their direct contribution to the seller's cash flow dries up.

Operating a trading business is no different from operating any other business. Claims that trading requires different business practices, situations, policies or relationships between employer and employee are merely excuses for the continued unethical practices that permeate our industry.

While there may possibly be "ethical" prop trading firms, they can only make such a claim if they do not call the relationship between themselves and their customers "a job," or even "employment."

Perhaps calling it, "pay for training," would restrain my critique... but probably not.

Adam Sterling.

Brett Steenbarger, Ph.D. said...

Hi Adam,

Good points. The crucial question is whether someone *who already possesses the requisite knowledge and skills* can join the prop firm without going through the paid training. If so, that sounds legit to me.

There are many firms where education/training is separate from, but related to, the main business area. For instance, security firms will offer training classes for those wanting to enter the field or upgrade their skills. They also may draw upon participants in those classes when they are hiring for security officers.

Similarly, fashion agencies may run classes for aspiring or developing models and then may select from the best students to offer agency representation and actual modeling jobs.

In such cases, the firm gets a good look at a student before hiring, but the education is separate from the hiring--and people can be hired independent of the training.

A prop firm that offers substantive training to developing traders and that may extend trading opportunities to the best students is different from a firm that offers a fig leaf of education at inflated prices in exchange for the illusion of prop trading.

Knowing which is which is important to those who are considering such a trading/training path.


Brett Steenbarger, Ph.D. said...

Much thanks, Tony. This topic is a real minefield, but I didn't feel comfortable not addressing it as best I could.


Adam said...

Brett ~

Thank you for your reply. Here's mine:

If a firm wants to sell education in a particular field, let them then open a school, call it a school and call their customers students.

Let them also be subject to the state and federal regulatory structures schools are subjected to ~ arcane, even Kafkaesque ones.

Further, let us judge these trading schools by the quality of their faculties and successes of their students.

There are indices by which we are able to track the success of graduates from various schools in a spectrum of fields.

Access to such information enhances market transparency. Isn't that what we trading professionals are always wanting more of?

In the absence of these conditions, a scam is still a scam.

The modeling "industry" (to which I had extensive and sometimes horrified exposure) is famous for its "training" scams.

As many girls who hope to be models will make it onto catwalks as schoolyard guys will make it into the NBA. Portfolio mills abound, ever ready to manufacture hope (and ugly sorts of personal tragedy) for the hope-filled (hopeless).

Trading, the NBA, modeling, search engines, NY Times best sellers... they all have something in common: a Pareto curve best describes the distribution of rewards... and will continue to do so.

Any claim to the contrary... that such odds can be overwhelmed... is exactly what you were railing against in your f'em post.

Kind thoughts.

Adam Sterling.

madi said...

Your blog and books have become valuable tools for me and others to whom I've recommended this site.

I suspect that learning to trade at a prop firm is akin to learning to perform music at a music school. I didn't learn to play music at school. I have a M.A. in music performance and composition and can honestly say that my experience at school pales in comparison to the work I've done on my own and on stage.

Like music, I think that if someone is going to really be successful at this, then they have to be able to think outside the box and not trade a cookie-cutter approach which schools try to offer. I'm a self-taught trader who has spent quite a lot of money on the school of Hard Knox tuition. It has led me to incredible growth and understanding of the markets and myself. I have my own unique and successful method of trading that is a result of a creative and scientific process that is on-going and in a continuous state of evolution and development. I wouldn't have it any other way.

I tell traders to study as much as they can, start off slow, and read your blog. That's all they need.

Tariq said...

Dr. Steenbarger,

I want to approach this discussion from the point of a self employed trader. Adam and Medi have made excellent points along with you ( which you always do).

There are quite a number of traders
who decide to become traders after trying a number of other professions. Some of them have been successful at other professions but want to become a full time trader for various reasons.

I have been trading full time ( have been following market for 4 years) for a year. So far, I am self taught via books, trading my own account etc. I strat 7.00 am in the morning and normally continue till 10 pm ( most of the time is spent on reading).

It's O.K to keep on experimenting and trying to find your personal style if you have another job but when you are trading full time and at some point expect to make a living from this endeavour, it's imperative that you have professional training by someone reputable. Learning on your own- the opportunity cost is VERY VERY HIGH for full time traders.

I have not been able to find and trust one due to the reasons Adam Sterling have pointed out.

I may one day start a teaching institution for traders ( based on the principles outlined by Adam Sterling and Dr. Steenbarger) because I have never came across a wider gap between the demand and supply in any other industry.

Best Regards,
Tariq Malik

jt said...

Dear Mr Steenbarger:
on the issue of SMB - i recently left a comment to "Bella's" article asking for his track record. Not only was the comment removed i also received a notice from my email account administrator that they have been notified i send a spam email?! Do you truly believe such behaviour shows professionalism and integrity?