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Prop Trading by Stock Brokers in India – A risky proposition

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Concern over proprietary trading among Indian brokers over the security of their clients’ funds is growing. As earnings from the retail broking sector continue to decline, many brokers choose the path of Prop Trading to boost revenue.

According to data from SEBI as of December 2015, the percentage of overall trading volume that is accounted for by proprietary trading is as follows:

  • 50% in Equity Derivatives Segment of BSE and NSE
  • 20% in Equity Cash Segment of BSE and NSE
  • 43% in Agriculture Commodities Segment of MCX
  • 21% in Non-Agriculture Commodities Segment of MCX

Brokers are required by regulators and stock exchanges (NSE and BSE) to keep separate books and account for their proprietary dealings. However, this does not prevent brokers from using client funds for intraday transactions, making it a risky proposition for its retail clients.

Most stock brokers do not inform their clients or the public of this danger on their websites. It is quite difficult to locate the balance sheet indicating how much revenue is coming from the prop desk because none of the discount stock brokers in India are listed on the stock exchange.

What is Prop Trading by Stock Brokers?

Prop trading, also known as proprietary trading, is when a broker trades with its own funds in an effort to benefit personally. Pro-account or OWN account is the name of the account that the broker uses for prop trading.

To execute the trades, the stock broker’s prop desk makes use of highly qualified personnel, complex algorithms, fast servers positioned beside exchange servers, and high bandwidth networks.

Since they charge a fee for each exchange transaction and compensate brokers for the use of their infrastructure (such as high-speed servers, data centers, and network lines), stock exchanges see a rise in revenue as a result of prop trading.

Many brokers are known to have proprietary trading books valued between Rs 100 and Rs 800 crore in FY 2015–16, according to a major publication. Few brokers even stopped their retail operations in order to concentrate solely on active prop shops because the industry is so profitable.

More brokers are more aggressive in their prop trading activities in an effort to boost earnings due to low retail involvement in the Indian stock market and pressure to enhance revenue.

How Prop Trading Works for Stock Brokers?

Technically, the broker utilizes its own funds and a separate trading account for Prop trading. However, realistically speaking, they trade with the same margin money, which is partially paid for by the consumer. Following are two typical scenarios:

Scenario 1 –

For open positions, the client makes a margin payment. Clients also store additional funds in their trading accounts in case they need them for future trades or additional margin. Brokers who engage in prop trading use the margin funds and excess cash for their own margin.

Scenario 2 –

The margin requirements for open positions on the stock exchanges are high, although the obligations apply to the “End of Day” balance.

Almost all positions in Prop Trading by stock brokers are closed on the same day (day trading). As a result, the broker still fulfills the exchange’s EoD margin requirement without spending any additional funds.

Utilizing the extra cash from clients, some positions that cannot be closed the same day are kept overnight.

What are the risks of Proprietary Trading?

When a stock broker engages in prop trading, his risk is comparable to the risk that an individual trader assumes when he borrows money (all or part of it) and trades during the day.

If the market swings abruptly, a technical problem arises, or a trader working for the broker makes human errors, the broker may suffer huge losses that could lead to:

  • Broker could corrupt the bank.
  • If a broker fails to complete their End of Day obligations to stock exchanges, they will be subject to severe fines. Brokers run the chance of losing their membership.

The risk varies depending on the market volatility, how aggressively your broker uses prop trading tactics, and how much extra cash they hold.

It’s quite challenging to estimate the risk for the money clients keep with brokers because there is no simple way to learn how your broker participates in prop trading.

Which brokers do Prop Trading?

Most conventional brokers engage in one or more aspects of prop trading.

Prop Trading is done by some bargain stock brokers, including RKSV (Upstox), Zerodha, and SASOnline.

RKSV and SAS Online confirmed that they had drastically reduced their Prop trading operations over the past year and will keep doing so.

The biggest cheap stockbroker, Zerodha, is actually expanding its Active Prop Desk. As of December 2016, Zerodha’s prop desk is managed by a committed staff of approximately 100 traders (workers).

Which discount brokers don’t do Prop Trading?

Few inexpensive brokers don’t engage in Prop trading. Among the few well-known discount brokers that do not engage in prod trading are ProStocks and Tradejini.

ProStocks is a Mumbai-based online stock broker that provides fixed monthly trading plans and flat-rate trades of Rs 15. (unlimited equity trades at Rs 899 or unlimited currency trades at Rs 499 per month).

Brokers who don’t engage in Prop Trading give much higher client money security.

How to secure the money with the broker?

  • Customers must take extra precautions to protect their money if they have an account with a broker who engages in proprietary trading. Here are some pointers:
  • Keep any extra funds out of your brokerage account.
  • Just before making a buy, transfer funds from your bank account to your trading account.
  • Don’t leave money in the trading account if you sold equities and don’t plan to use the proceeds to purchase other shares. Get it moved as soon as possible to your savings account.
  • If you don’t want to deal with the trouble of removing money from a trading account, invest in liquid funds that pay interest everyday, such as Reliance Liquid Fund’s Treasury Plan and Growth Option. With your money safe and liquid in this fashion, you can make money off of your parked cash.

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