Posted on Friday, December 30, 2016
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Proprietary trading is a growing concern for safety of the clients money with brokers in India. Many brokers choose the path of Prop Trading to increase revenue as earnings from retail broking business is keep going down.
As of Dec 2015, As per statistics provided by SEBI, the proprietary trading contribution out of total trading volume is:
Regulators and stock exchanges (NSE and BSE) require broker to maintain separate books and account for their proprietary trades. But this doesn't stop brokers from using the clients money for their intraday transactions, which makes it a dangerous proposition for its retail customers.
Most stock broker do not disclose this risk on their website or to the clients. As none of the discount stock brokers in India are listed in stock market, it's very difficult to find the balance sheet showing how much revenue is coming from prop desk.
Brokers putting their skills to make money for themselves
Prop Trading (or proprietary trading) is trading by the broker using it own money to make a profit for itself. The account used by broker for prop trading is called Pro-account or OWN account.
Stock broker's prop desk uses highly skilled employees, sophisticated algorithms, high speed servers co-located with the exchange servers and high bandwidth networks to execute the trades.
The revenue of stock exchanges also increases though prop trading as they charge the exchange transaction fee and rent the equipment and infrastructure (i.e. high speed server, data center, network lines) to the brokers.
As per a major newspaper, many brokers are rumored to have proprietary trading books worth Rs 100 - Rs 800 crore in FY2015-16. The business is so profitable that few broker even closed the retail business to focus only on active prop shop.
Low retail participation in India stock market and pressure to increase revenue is pushing more broker to get aggressive in the prop trading operations to increase profits.
Technically broker uses a separate trading account and its own money for Prop trading. But practically they use the same margin money which is partly paid by the customer for their own trading. Here are two popular scenarios:
Client pays margin money for open positions. Clients also keep extra money in trading account in case need arise for additional margin or for trades in near future. Broker involve in prop trading uses this margin money and surplus cash for their own margin for prop trades.
The stock exchanges has strict margin requirements for the open positions but the obligations is for the 'End of Day' balance.
In case of the Prop Trading by stock broker, almost all positions are closed on the same day (day trading). Thus it broker still meet the EoD margin obligation by the exchange with no additional money.
Some of the positions which cannot be closed on the same day are held overnight using the surplus money from clients.
The risk for a stock broker involve in Prop Trading as similar to the risk an individual trader takes when he borrows money (some or all) and trade intraday.
If market swings unexpectedly, technical issue happen or manual mistakes made by the trader working for the broker, the broker may hit with significant losses which could result in to:
The risk changes based on how aggressive your broker goes with prop trading strategies, the market volatility and amount of surplus money the broker hold.
As there is no easy way to find out how your broker is involve in prop trading, it's very difficult to quantify the risk for the money clients keep with brokers.
Most traditional brokers does prop trading in one or more segments.
RKSV and SAS Online did confirm that they have scaled down the Prop trading operations significantly in recent year and will continue doing that.
Zerodha, the largest discount stock broker is actually ramping up its Active Prop Desk. As of Dec 2016 Zerodha has a dedicated team of over 100 traders (employees) running the prop desk for them.
ProStocks is Mumbai based online stock broker offering flat Rs 15 per trade and fixed monthly trading plans (unlimited equity trades at Rs 899 or unlimited currency trades at Rs 499 per month).
The brokers who are not involve in Prop trading offers significantly better security of client's money.
If you have an account with a broker who is involve in proprietary trading, extra precaution is required by the customer to safeguard the money. Here are few tips:
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