Proprietary Trading is defined as the case when a trading desk of an investment bank/financial entity trades any securities (shares, bonds, derivative etc.) using its own money rather than using depositors’ money to gain from short term price movements.
Proprietary trading is a high-risk form of trading activity where traders book their own speculative positions or arbitrage any opportunity in order to generate quick profit using its own capital instead of acting on clients orders.
Traders engage in proprietary trading to generate quick and excess returns by taking speculative positions in the capital market. It helps traders to trade when there is no orders from the market which improves liquidity in the capital market and generates excess return for the bank.
The biggest disadvantage of proprietary trading is lack of control or lack of proper risk management process which leads to huge losses by trading desk. Not all the time, these speculative investments generate profit. There are cases when an investment bank went bankrupt or incurred huge losses incurred by rogue traders engaged in proprietary trading. Volcker rule was passed by US government to prohibit Proprietary trading by the banks using customers’ funds so that customers’ funds will not be a risk at the end.