How Prop Firm Challenges Work

Before a trader receives a funded account to trade for real profits, a prop firm usually stipulates traders to go through the challenge and verification phases to prove their ability to handle the real funded account. Challenge phases are an important part of prop firm trading. It’s a training ground. Some firms offer free educational resources during this phase to help traders develop their trading skills. Some firms apply the same risk management rules for both challenge and funded stages while some firms may have some stricter rules imposed upon for live funded stages. Below guide will help you understand about prop firm’s challenges from choosing a challenge account type to the transition to a funded account. 

1. Choosing an Account Type

Prop firms mainly offer challenge account sizes ranging from 5000 USD to 200,000 USD for a fee. Prop firms like FTMO, FundingPips charge only a one-time fee for buying the challenge while other firms like Apex Funding offer a monthly fee for trading an account, usually the monthly fee is smaller than a one-time fee, but you have to pay every month. Prop firms usually restrict the account leverage to control risk unlike a brokerage that allows you to choose varied account leverage on favor. Different firms set different leverage models for their accounts. The max drawdown limit is expressed in percentage relative to the initial account balance. Most firms sell their challenge accounts with a refundable fee. Based on different firms, a trader may get back his refundable fee at the first payout or second payout. Most instant funded accounts do not have refundable fees. 

2. Understanding Profit Targets

Typical profit target ranges from 5% to 12%. New firms try to introduce lower profit targets to attract new customers and compete with other firms. However, you should be careful. Though the profit target is lowered, they may have other restrictive conditions to make up for the lower target. Profit target is calculated based on the initial account balance. For example, the 100K account with a 10% profit target is 10,000$. The profit target remains fixed throughout your trading period. The profit target is not based on account equity. Equity refers to the fluctuating amount while trades are opened. Account balance remains fixed until all trades are closed. Keep in mind that a profit target is based on an account balance. Trades must be closed to reflect the balance and so determine whether the profit target is reached or not. Firms do not automatically close the trades when your profit target based on equity is reached. 

3. Understanding Drawdown Rules

Prop firms mainly impose 2 drawdowns for an account. Daily Drawdown and Max Drawdown. Daily drawdown is the maximum amount in your account you can lose within a trading day. Most 2-step challenges set 4-5% as the daily drawdown limit. This daily drawdown gets reset once per day at the market closing for the new trading day at around 4:00 PM Eastern Time. On the user dashboard, there will be a countdown clock to show when the reset time arrives. 

There are two types of drawdown: balanced-based and equity-based drawdown. Balance-based drawdown is when the judge occurs only after all trades are closed so even during the trade holding, the equity fluctuates and violates the daily loss limit, the account won’t be breached. This leaves some room for trading. For equity-based drawdown, it is based on the fluctuating equity while trades are open. Balanced-based drawdown is more preferred by traders.

Another important thing to be aware of is trailing drawdown. It can be both daily and maximum drawdown, specific to a firm. For the case of daily loss limit with trailing, you must be careful because the max daily drawdown constantly moves based on the equity fluctuation, taking the most extreme point when price reaches certain levels. 

For example, your account is 100K with a daily trailing drawdown limit of 3% (3000$) and you open a trade using 1% risk for the trade and Take Profit of 4 times the risk (RR 1:4). Before you enter the trade, the lowest account equity to breach is 97000$ (100K minus 3000). Let’s say your trade goes well and you reach a gain of 3500$. At this time, your trailing drawdown limit has moved to 100500 (103500 minus 3000). Unfortunately, the price bounces back by 3001$ causing the equity to become 100499$ (103500 minus 3001). In this case, your account will be breached due to the violation of daily loss limit based on trailing drawdown. Anything can happen in the market so it’s best to stay in the safe zone in the worst case scenario. As a trader, you must understand the drawdown model on your account very clearly to avoid losing account due to ignorance. 

Maximum drawdown refers to the maximum loss in your account in its whole life. Maximum drawdown can be both balance-based and equity-based. For equity-based max drawdown, the drawdown limit will be reset daily when starting a new day. For balance-based max drawdown, the breach level stays fixed throughout your trading period. For example, your account has a  balanced-based max drawdown limit of 8% for 100K, so as long as your account doesn’t go below 92000$, your account will be okay. You must be aware that both equity and balance violation will cause breach for max drawdown. 

4. Trading Rules During the Challenge

Prop firms now have two main types of trading challenges for their traders: CFD and Futures. For beginners, CFD trading is more simple and it’s the best way to get started. With CFDs, there are several instruments a trader can trade such as Forex pairs, Indices, Commodities like gold, Energy like USOIL (WTI), Stocks like Tesla, Cryptocurrency like Bitcoin, Bond CFDs, and ETF CFDs like SPY (S&P 500 ETF). Different firms provide different instruments to trade. Remember CFD is just a contract for difference; you don’t hold any assets trading this model.

Prop firms may restrict holding trades over news or weekends. For high-impact news releases (identified as red on ForexFactory), some firms impose no trading transactions like entering new positions, pending order triggering, hitting Stop Loss or Take Profit but holding trades through news releases are allowed. Some firms even ban holding through the news and I don’t recommend trading this firm. Holding through the weekend is allowed with some firms based on challenge types. Some give it as an optional add-on when buying the challenges. 

Most firms allow the use of Expert Advisors (EA) for trading but they don’t allow the use of a commercial EA selling to the public in the market. Personally-owned EA is allowed. Some firms have specific rules for copy trading but make sure you understand the main purpose of copy trading. Copy trading from third parties is strictly prohibited. Some firms may request you to prove your own trading with copy trading setup. You can also use a VPS to trade, run your personal EA, or copy trading. Some firms do not allow copy trading. Lot sizing is determined by the firm through the setting of leverages for different accounts. Some firms state the maximum lot size openly as their rules. You must understand how many lot sizes you can open your trade to make sure there will be no obstruction of opening positions during trading. 

More firms are using consistency rules nowadays but I see it more as a restriction of how traders trade than as a way to help traders control risk well. For example, a firm imposes a 20% consistency rule for an account type. It means that profit alone is not enough; you have to make sure that the most profitable trading day (highest profit day) shall not be more than 20% of your total profit for payout. For example, you have a 100K account and take 1% risk per trade per day. After two weeks of trading, you made 6% or 6000$. You set a fixed TP for each trade at 1:2 RR, meaning each trade will make 2% or 2000$ profit if successful. In this case, you won’t be able to withdraw 6% profit because you fail the consistency rule (2000$/6000$ = 0.33 or 33% > 20% consistency rule). In this case, you have to keep trading until you reach a higher profit that makes you pass the consistency rule. For myself, I hate firms with consistency rule. Some firms use this rule just to attract beginner traders to buy the challenges without clear understanding the restriction by offering much discounted price compared to a regular challenge account without consistency rule; it’s like a trap. Nonetheless, consistency rule of like 50% may still be okay.

5. Time Limits and Minimum Trading Days

Most firms do not limit time for traders to pass their challenge unlike in the past. Traders can take as much time as they wish to complete the challenge as long as they don’t break any rules. Minimum trading days are also imposed for some firms. Some define it as the day traders open at least one trade while some define it as the day traders open trades and make at least 0.5% profit. Before buying the challenge, you must understand this clearly. Firms mostly restrict the minimum trading days to stop traders from requesting the payout too soon. Most firms talk about active working days versus calendar days. Prop firms consider only working days from Monday to Friday to determine the period a payout is processed. Weekends are excluded. Trading a prop firm should be done slowly; you don’t need to rush. Abandon the idea of passing a challenge within a few days. Consistency matters more than speed. 

6. Passing or Failing the Challenge

Reaching target profit is the main goal of passing a challenge; however, making target profit alone doesn’t guarantee you to the next phase. Trading a prop firm stresses on how you reach that profit target. It means passing the profit target while obeying all the rules. 

The #1 killer is over-risking. Many try to risk too much per trade so they can pass the challenge fast; they end up breaking daily or max drawdown. Overtrading is another big killer. Trading outside the sessions, taking lower-quality setups or taking trades out of boredom are the examples of overtrading. Moreover, trading during high impact news releases like NFP, CPI or FOMC fails many challenges. During this high volatility, slippage and spread are widened; stop loss hunting breaks the established structure. Many challenges die in one news candle. Strategy hopping mid-challenge is another cause of failing a challenge. Traders lose trust in their system after one or two losses in a row and they try new strategies hoping to recover. Finally, they meet more losses and change their strategy again. The one that suffers is your challenge account. Not understanding the drawdown rules clearly is another common cause. There are different types of drawdown limits like static, equity-based, and trailing drawdown. Strategy mismatch with prop rules is another setback. Make sure your strategy, plan, and prop firm rules are aligned well. 

If you fail a prop firm challenge, some firms allow you to reset the account by paying a fee, often at a discounted price. You have the choice to buy new challenges instead. Failing challenges in prop firm trading is normal. Statistically, only less than 5% of traders manage to pass a challenge. There are also new firms that offer free retake after failing the first time, but the conditions of your retaken account may not be the same; for example, they may lower the profit split percentage for payout. 

7. Transition to a Funded Account

Most prop firms keep the rules the same when a trader gets to a funded stage while some may slightly change some rules. For example, regarding news trading rules, at challenge phases on FundingPips, a trader is free to trade through the news releases without violation. But when they are at the funded stage, the firm imposes no trading transactions triggered within the 5 minutes before and after a high-impact news release; these include opening new positions, triggering pending orders, modifying Stop Loss and Take Profit, and hitting Stop Loss and Take Profit. Some firms may adjust the leverage at the funded stage. Moreover, when a trader gets a funded account, he is required to conduct the KYC process for compliance purposes by submitting their ID document along with a live selfie. To get paid, a trader may need to have a Riseworks account or cryptocurrency wallet to receive the payment. 

8. Common Misunderstandings About Prop Firm Challenges 

Common misunderstandings prevail about prop firm challenges. First, the fact that you pass a challenge does not guarantee payouts because some traders may pass a challenge out of luck, not by consistency. Certain aspects of their strategy are still at high risk of failing the account rules. Of those who are funded, roughly 20 % go on to receive at least one payout, meaning a funded status doesn’t guarantee being paid.

A funded account does not mean unrestricted trading. In fact, the common thing is at the funded stage, the rules tend to be stricter or the same. Another misconception is thinking that a challenge account is the same as a demo account on a brokerage. They are not. Most prop firms usually use simulated trading environments for traders, which means that the slippage, execution and spreads replicate more or less a live account on a brokerage. This real market condition causes more difficulty compared to a normal demo account on a broker.

On modern prop firms, speed is no longer a requirement. You can take as much time as you want to pass a challenge. Many traders try to rush the passing without building a true consistency, which causes them to fail in the future inevitably. Trading on a prop firm is harder, emphasizing strong risk management and discipline. Lastly, one passing does not mean that you have consistency yet. You might be lucky risking 3% per trade, hitting a 4 RR trade and passing in one trade. But that is not consistent. Trading on a prop firm necessitates survival and resilience for a long-term result. 

Final Thoughts

It’s quite easy to get started with a prop firm trading these days and there are many choices available in the market. You spend lower fees to manage massive funds while the firm bears the risk for you. Just open an account and start purchasing the challenges. Then, you will be provided with a trading account’s credentials and trading platform to start trading. Bear in mind that the challenge comes with its rules set by the firm. Make sure to understand the rules clearly to avoid getting breached due to rule violation. Read its FAQ page several times and if you are not clear for any points, approach the firm’s support to clarify things. Prop firm trading is an opportunity for you to build yourself a profitable trader. Some firms provide educational resources to help you. Approach prop firm trading with discipline and you will find your way towards success. Treat the challenge as a real business. Read my beginner guide here to help you become a prop firm trader who survives and makes it.