Prop Trading Firms vs. Hedge Funds

Created on May 12, 2025

Proprietary trading firms and hedge funds both play a significant role in the trading industry, and traders often use the terms “prop firm” and “hedge fund” interchangeably. However, they are two very different animals. They have different structures, regulations, and ways of accessing capital.

Let’s look at both entities—how each operates and compare their differences and similarities.

What Is Prop Trading?

Prop trading firms allocate capital to other traders, and the traders receive a share of the profits they generate. Traditional prop firms have a physical location where the traders work, while online prop firms allow traders to be located anywhere in the world without requiring their physical presence at an office.

Online prop firms find traders through a “challenge” or test, where traders pay a fee for an evaluation period. The traders must meet specific profit targets and other criteria, such as keeping the account within maximum drawdown limits. The prop firm allocates a profit-sharing account when they pass the challenge or evaluation period.

Prop firms trade a variety of asset classes, including equities, Forex, futures, and options. Traders mainly utilize their own strategies, especially with online firms, rather than trading a strategy given by the prop firm.

Because prop firms do not take external client money, they are not regulated in most parts of the world.

What Is a Hedge Fund?

A hedge fund is a private investment fund that trades with capital typically from “accredited investors.” To qualify as an accredited investor, an individual or entity usually must meet minimum financial criteria or other qualifications. For example, in the U.S., an investor must have earned $200,000 in income in the prior two years, have a $1m net worth excluding their primary residence, or be a licensed registered broker or investment advisor. Other countries usually have similar criteria for accredited investors.

Because hedge funds handle client capital, they are usually regulated. In the U.S., for example, advisers who manage private funds of more than $150m require SEC registration.

Differences Between Hedge Funds and Prop Trading Firms

1. The primary difference between prop firms and hedge funds is that prop firms give their own capital to other traders, whereas hedge funds manage external capital, typically from accredited investors.
2. Because hedge funds manage external capital, they are subject to regulation in most countries. For example, the U.S. requires SEC registration when a hedge fund’s assets under management exceed $150m. In contrast, prop funds are mostly unregulated.
3. Hedge funds are accountable to investors. Prop firms are not accountable to anyone but themselves.
4. Nearly anyone worldwide can apply to trade for an online prop fund. Hedge funds normally employ individuals with professional industry experience, such as fund managers, investment bankers, economic analysts, mathematicians, etc.
5. Hedge fund staff work as a team within a corporation, under a shared vision, and usually from physical offices. Prop firm traders, particularly online prop firms, work independently, trading their own strategies, and often never meet each other.
6. Hedge funds often trade in non-publicly available securities, such as bespoke derivatives, private assets, real estate, etc. Prop firm traders instead tend to stick to instruments available to any retail trader: Forex, futures, options, publicly listed equities, etc.
7. Hedge funds normally charge a management fee to clients, e.g., 2% of assets, as well as a performance fee. Prop traders only get a performance fee, i.e., they do not get paid if they do not make money trading.

Similarities Between Hedge Funds and Prop Trading

1. Prop firms and hedge funds operate across multiple asset classes: Forex, futures, options, etc.
2. Prop firms and hedge funds can take long or short positions.
3. Both can consider asset classes outside of their home countries, e.g., U.S. prop firms or hedge funds may both take positions in foreign equity index futures, such as the UK FTSE 100 index.
4. They both aim to achieve positive returns, regardless of benchmarks. Let’s say the S&P 500 declined by ten percent. It’s not good enough for a prop firm trader or hedge fund to achieve minus five percent, even though they beat the world’s largest equity index. They still lost money, which means they have not achieved their goals.

Prop Trading Strategies

Many prop firms do not allow traders to hold overnight or weekend trades, so prop firm traders tend to utilize shorter-term strategies. Because of this short-term bias, most prop firm traders employ technical analysis rather than fundamental analysis since changes in the economy or an equity’s financial strength can take longer to affect the market price.

However, some traders may trade major economic data or earnings announcements because some specific fundamental news items have a reliable track record of moving the market instantly, allowing traders to capture short-term moves.

Prop-trading is not a one-size-fits-all approach—traders can use any short-term trading method they can implement profitably. Some may use price action trading, i.e., chart patterns, and support and resistance analysis. Others may use indicator-based approaches, volume profile, or mathematical rule-based algorithms. Prop traders can be trend-following or follow the countertrend. Some prop traders stick to one or two instruments, whereas others may follow more than a dozen instruments. It’s entirely the trader’s choice on how they achieve the profit goals set out by the prop firm.

Hedge Fund Investment Strategies

Some hedge funds trade in traditional ways, using technical and fundamental analysis to predict price changes and taking long or short positions in conventional asset classes, such as currencies, precious metals and equities.

However, one of the advantages of hedge funds is that they can trade in almost any way they want and can bring hundreds of millions or billions of dollars to the table. For example, some hedge fund managers buy controlling stakes in publicly traded companies to sell off assets of the target company, rebuild the business, or even replace CEOs. Hedge funds can even develop new trading instruments. Dr. Michael Burry famously approached investment banks to create derivative products so his hedge fund could profit from his prediction of the subprime mortgage crisis in 2008.

Hedge funds typically have longer time horizons than prop traders. That means they can trade global macroeconomic events, such as wars or economic shifts, that can potentially take longer to affect the markets of certain assets.

Regulation and Risk Management Differences

1. There is no regulation governing prop firms, whereas most countries regulate hedge funds because they invest external capital. In the U.S., hedge funds managing over $150m must be SEC registered.
2. Hedge funds must have anti-money laundering procedures because they accept external capital.
3. Some countries require hedge funds to disclose their holdings at regular intervals, e.g., quarterly, and when they own more than a specific percentage of publicly traded companies’ voting rights (e.g., 5% in the U.S.).
4. Prop firms lay out risk management rules for their traders. Hedge funds can decide their own risk management rules and are often willing to place bigger, riskier bets. A hedge fund famously nearly went bankrupt taking a short position in GameStop equity when the price increased sharply.

Performances During Different Market Conditions

Both hedge funds and prop firms aim to deliver absolute, positive returns regardless of the benchmark or the performance of other markets. This is a key reason why they exist. For example, it does not matter if the S&P 500 went down over the year; a hedge fund or prop trader would still aim to have a positive return.

Of course, market conditions affect returns. Periods of low volatility may make it harder for either group to perform because price movements are critical to profit. Some quarters or entire years provide excellent trending markets, whereas other periods can be messy, and range bound.

Required Skill Sets for Prop Firms versus Hedge Funds

1. Hedge funds employ professionals with industry experience. Many hedge fund employees will have relevant qualifications, e.g., Chartered Financial Analyst (CFA) designations, degrees in programming, mathematics, economics, etc. Remember, hedge funds are a professional environment, and the employees reflect that with experience and qualifications.
2. The advantages of prop firms are that they do not care where you are located or your experience. If someone can pass the “challenge” period for an online prop firm, they will get access to a profit-sharing account, and they can begin trading immediately. Prop firms only care about verifying someone’s skills.

My Take

Prop firms and hedge funds are strikingly different. Both bring with them their own advantages and disadvantages. If you are interested in developing a career in a professional environment, a hedge fund may be right for you. If you feel you have the skill to trade short-term moves profitably, an online prop firm can give you access to trading capital with a share of the profits.

Hedge funds are well-regulated in most countries because they take external capital. Prop firms are generally unregulated, so choosing a prop firm means doing due diligence before deciding which firm to use.