Understanding the difference between proprietary trading firms and hedge funds helps explain how each operates in the financial markets. Proprietary trading firms, often called “prop shops,” trade with their own capital. Their main focus is to profit from short-term price changes in stocks, bonds, or other assets. These firms often use advanced trading technology and algorithms to make quick decisions. Since they use their own money, they can take more risks and react quickly to market changes.

Hedge funds, on the other hand, collect money from outside investors. These investors expect steady returns over time, so hedge funds use a wider variety of strategies, such as long/short equity, global macro, or event-driven trades. Because hedge funds manage other people’s money, they face more regulations and must provide regular reports to their investors. For example, while a prop firm might try to make money from rapid price swings in tech stocks using high-speed trading, a hedge fund might try to deliver stable returns by holding a mix of stocks, bonds, and derivatives. in this article, we will discuss about Proprietary trading vs hedge funds. 

What is The Difference Between Proprietary Trading and Hedge Funds?

Proprietary trading and hedge funds are both active in the financial markets, but their structures, goals, and the way they operate are quite different.

Proprietary trading vs hedge funds, what are the differences? Proprietary trading involves firms using their own money to buy and sell financial instruments. Traders in these firms make decisions quickly, responding to real-time market changes. Since they’re dealing with the company’s money, any gains or losses directly impact the firm’s financial health. This setup often leads to a fast-paced environment, where quick thinking and discipline play a big role in success. For example, many trading firms in New York or London have teams who focus on split-second trades in stocks, bonds, or derivatives. Many proprietary trading firms also offer support, resources, and mentoring programs to help traders refine their strategies and succeed in high-pressure environments. In addition, it’s important for traders to understand risk parameters that are established and communicated upfront to ensure alignment with firm expectations.

Hedge funds, on the other hand, manage money collected from outside investors. Their managers invest this pooled capital into a range of assets, often with a strategy aimed at achieving steady returns over time.

Because they’re handling other people’s money, hedge funds must follow strict regulations and report certain details when they reach a specific size. If a hedge fund makes a bad investment, it’s the investors—not just the firm—who share in those losses.

This responsibility tends to make hedge fund managers more cautious and focused on protecting their clients’ capital.

Both approaches carry risks, but the impact of those risks falls on different people. In prop trading, the firm itself absorbs the ups and downs, while in hedge funds, investors share in the results.

A major distinction is that proprietary trading firms often provide access to substantial capital for their traders, which can enhance potential gains but also increases the stakes involved.

Do Prop Traders Get a Salary?

Yes, prop traders can receive a salary, though the structure varies depending on the firm. Some proprietary trading firms offer a base salary to their traders, especially at the entry level, where earnings can range from $50,000 to $120,000 per year. More experienced or senior traders often make over $150,000 annually, and many firms also provide additional income through bonuses or profit-sharing arrangements. In summary, while not all prop trading roles guarantee a fixed salary, many do offer a combination of salary and performance-based compensation.

Core Strategies and Investment Approaches

Investment strategies are at the heart of both proprietary trading firms and hedge funds, but their goals and day-to-day practices show clear differences.

Proprietary Trading: Fast-Paced, Short-Term Tactics

Proprietary trading firms use their own money to try to make a profit from quick changes in the market. They often focus on short-term tactics such as high-frequency trading, market making, and arbitrage.

These approaches depend heavily on technology and detailed mathematical models to buy and sell large amounts of stocks, currencies, or other assets in just fractions of a second. The aim is to benefit from small price movements, often without holding positions for more than a few minutes or even seconds.

For example, a prop trading desk might use automated systems to spot and act on price differences between exchanges. Some modern prop firms now offer immediate access to capital, allowing skilled traders to start trading without lengthy evaluation processes.

Hedge Funds: Broader Mix With Risk Management

Hedge funds, by contrast, use a wider range of strategies and usually manage money for outside investors. Their goal is to deliver steady returns while protecting against losses.

They might take both long and short positions, invest in global markets, or focus on events like mergers. Some well-known hedge fund strategies include long/short equity, global macro, and event-driven investing.

Hedge funds typically spend more time on detailed research and spread their investments across different assets to manage risk. For instance, a hedge fund manager may analyze company earnings, economic data, or political developments to decide where to invest.

Key Differences in Approach and Objectives

While both groups use advanced technology and data analysis, proprietary traders usually move faster and trade more frequently, aiming for quick wins using the firm’s own funds.

Hedge funds, on the other hand, often take a longer view and balance risk and reward for their investors. A key tool used by both is risk management practices, which help ensure that trading strategies protect against significant losses and maintain long-term profitability.

Regulatory Environment and Oversight

Understanding how regulations affect proprietary trading firms and hedge funds helps explain why they operate differently. Proprietary trading firms typically use their own money to make trades and don’t manage outside clients’ assets. Because of this, they face fewer regulatory requirements and less oversight from agencies like the Securities and Exchange Commission (SEC).

These firms aren’t required to register as investment advisors or provide as much information to the public, allowing them to keep their strategies more private. Effective risk management is particularly important for proprietary trading firms, as they rely on internal controls rather than regulatory mandates to safeguard their capital. A key part of their approach is setting clear rules to keep emotions in check and limit potential losses.

On the other hand, hedge funds manage money for outside investors. This role comes with more responsibilities and stricter rules. Once a hedge fund’s assets under management cross certain thresholds, the fund must register with the SEC.

This registration requires the fund to regularly file reports, share details about its holdings, and meet standards designed to protect investors. Hedge funds also must follow Anti-Money Laundering (AML) and Know Your Customer (KYC) policies, which are meant to prevent illegal activities and ensure they know who their clients are.

These rules increase transparency and help build trust with investors and regulators.

There are also rules that affect how banks can use their own funds for trading. The Volcker Rule prevents banks from engaging in most forms of proprietary trading, but it doesn’t apply to hedge funds in the same way.

As a result, hedge funds have more freedom in choosing their investment strategies, while bank-affiliated proprietary trading desks must limit their activities.

Proprietary trading firms often keep a low profile, disclosing less information to the public since they don’t handle client money. In contrast, hedge funds must be more open about their operations because they’re responsible for protecting their clients’ interests and following the law.

This difference often influences the types of strategies each firm can pursue. Firms that operate as proprietary traders may also place greater emphasis on risk and money management to ensure sustainable performance without the burden of external oversight.

Compensation Structures and Profit Sharing

Proprietary trading firms and hedge funds both aim to generate profits in financial markets, but the way they pay their teams is quite different. At most prop trading firms, you keep a significant share of the profits you make—sometimes as much as 90%. This setup puts the focus on your personal results, so traders who perform well can see large payouts. A key part of success for many prop traders comes from emotional discipline, which helps avoid impulsive decisions and supports consistent performance.

There’s usually a base salary, but the real money comes from performance-based bonuses, which can vary a lot from year to year.

Hedge funds, on the other hand, use a different model. Managers usually earn a set annual fee, about 2% of the assets they’re managing, plus a performance fee—often 20% of the fund’s profits. Here, payouts depend on how well the entire fund does, not just one person’s trades. If the fund grows and delivers strong returns for its investors, everyone benefits.

This approach can encourage teamwork, since compensation is tied to the overall success of the fund rather than only to individual performance.

Understanding these differences helps you decide which environment might suit your skills and goals best. Prop trading often appeals to those who prefer to work independently and take bigger risks for bigger rewards. Hedge funds might attract people who want more stability and like working as part of a larger team.

Performance and Risk in Different Market Conditions

Financial professionals often study how hedge funds and proprietary trading firms handle different market environments because understanding these differences can help investors make better decisions.

Hedge funds usually take a cautious approach by spreading their investments across a range of assets and using methods like long/short equity strategies. This means they buy some stocks and sell others short, which can help offset losses if the market drops. Their primary goal is to reduce the risk of large losses and deliver steady results, which is important for meeting the expectations of their investors. A key component of these strategies is effective risk management, which helps hedge funds maintain capital preservation even during volatile periods.

Proprietary trading firms, on the other hand, tend to focus on quick trades that take advantage of short-term price swings. They often do well when markets are unpredictable because their strategies are built around spotting momentum and rapid changes. However, this approach comes with higher risk. If the market suddenly moves against their positions, these firms can face significant losses, especially since they often use borrowed money to amplify returns.

For example, during the market volatility seen in 2022, some proprietary trading firms reported gains above 30% in a matter of months, while many hedge funds aimed for more modest but consistent returns, often in the single digits. The trade-off is clear: prop trading firms can see big profits in active markets, but they also run the risk of steep losses. Hedge funds may not match those high returns during boom times, but their strategies are designed to protect against sharp declines.

Your approach to risk should line up with your personal investment goals and how you see the market evolving. If you value stability and lower risk, hedge funds may be a better fit. If you’re comfortable with higher risk for the chance at larger gains, proprietary trading might be worth considering.

It’s important to note that both strategies benefit from comprehensive risk management to help protect capital and minimize the impact of unpredictable market movements.

Proprietary Trading Example

Conclusion

Understanding how proprietary trading firms and hedge funds operate can help you choose the right path for your financial interests. Proprietary trading firms use their own money to make fast trades, often relying on advanced technology to quickly buy and sell stocks, bonds, or other assets. Their main goal is to make a profit for the firm itself, so they often focus on short-term opportunities and adapt rapidly to market changes.

On the other hand, hedge funds collect money from outside investors and manage these funds using a wide range of strategies. Hedge funds might hold investments for longer periods and often use more diverse approaches, including stocks, bonds, derivatives, and even real estate. They work to deliver returns for their investors, so their strategies are often more complex and designed to balance risk and reward over time.