Proprietary Trading vs Physical Trading: 5 Key Differences to Know

In the financial markets, there are different types of trading. Each has their set of different functions and steps for investors to follow. There are two methods that stand out: proprietary trading and physical trading. We will be discussing both of them along with five key differences you need to know.

As a trader starting out, it’s always a good idea to know some of the terminology. Once you finish reading, you’ll be able to understand what stands out between proprietary and physical trading. Let’s begin.

1. The definition and concept

Proprietary trading pertains to stocks, bonds, commodities, or derivatives. Individuals and firms take part in this type of trading. They will use their own capital as opposed to money belonging to a client. The concept is for traders to make profit through these trades.

They will use several different tools like analysis, market insights, and their own expertise. Such trading can also include discretionary, high-frequency (HFT), and algorithmic trading. So how does it compare to physical trading?

Physical trading for the most part deals with commodities. It also pertains to commercial trading as well. So you’re purchasing or selling commodities or physical goods. These can include oil and natural gas, precious metals like gold and silver, or wheat (to name a few). These are tangible assets as opposed to financial instruments.

2. Risk and reward

The risk and reward profile is another aspect that sets proprietary and physical trading apart. Proprietary trading will involve higher risk levels because of the speculation of the financial market. Gains and losses can be significant due to the amount of leverage investors use.

Physical trading is less risky mostly due to the supply and demand of the commodities. Price fluctuations can still pose a challenge. Yet, the traders can employ different strategies to ensure they mitigate as much risk as possible. In terms of profit, you can get significant gains.

However, those gains won’t be as large compared to proprietary trading. Also, significant losses are also possible in physical trading. Therefore, it’s important to employ strategies like hedging to ensure your losses aren’t wiping out much of your portfolio.

You should also consider the idea of using stop-loss orders and purchasing reasonable position sizes. This will help you avoid any significant losses that may occur. As a rule of thumb, consider setting a stop loss price of 5 to 10 percent below the purchase price. It closes the position when it reaches that lower price point.

3. Regulatory oversight

Proprietary and physical trading are both subject to different sets of regulations. In the case of physical trading, they need to follow such regulations that pertain to environmental concerns, fair trade practices, and quality standards. To give you an example, this can include commodity inspection, licensing, certification, and taxation are all part of the regulatory processes of physical trading.

Meanwhile, proprietary trading will focus on mitigating risks and making sure the markets are stable. Meanwhile, they also prevent any activities that can have adverse effects on the financial system.

Going further in-depth, regulatory agencies will monitor trading activities. What they’re looking out for are things like insider trading, market manipulation, and other practices that are considered abusive and unethical. Proprietary trading firms need to follow these strict regulations which include registration, reporting, and compliance.

These regulations are outlined by the Securities and Exchange Commission (SEC) in the United States, the Financial Conduct Authority (FCA) in the UK, and the European Securities and Markets Authority in the Eurozone countries (i.e - the European Union).

4. Market dynamics

Proprietary trading often occurs on trading platforms and exchanges that are electronic. Stocks, bonds, derivatives, and currencies are bought and sold around the clock. The markets in proprietary trading will be driven by various factors such as geopolitical events, economic indicators, earnings reports, and trading strategies. 

Those who participate in these markets will utilize tools and analytics for the purpose of finding trading opportunities. At the same time, they work to optimize their trading strategies in real time. 

Regarding physical trading, we’ve mentioned earlier that this pertains to buying and selling tangible goods or commodities. They are driven by factors such as weather conditions, supply and demand dynamics, geopolitical tensions, regulatory policies, and transportation costs among others. In a physical trading market, the transactions are much different.

This consists of negotiating deals, physical exchanges, and contracts. Buyers and sellers can interact directly with one another for the purpose of completing a transaction.

Either way, it’s important to consider performing your due diligence. You’ll want to keep watch of the news in regards to the commodities you’re focused on. For example, oil and gas commodities are typically on shaky ground due to geopolitical tensions in regions like the Middle East and Eastern Europe. 

5. Profit generation models

Finally, let’s take a look at the profit generation models. They are both shaped by factors like market dynamics, underlying assets, and the operational strategies being used. Proprietary trading relies on capital appreciation, which allows traders to capitalize on short-term price movements, arbitrage opportunities, and inefficiencies in the market.

Physical traders will profit from a spread between the purchase and sale prices of an asset. They’ll also profit from different factors like efficient logistics, supply chain management, and economies of scale. To help enhance profit margins, traders can also take part in activities like the warehousing, transport, and processing aspects of the supply chain.

Let PermuTrade handle you trading needs - whatever they may be

Whether you pursue proprietary trading or physical trading, PermuTrade can handle any concerns you may have about it. We have a team of experts that have worked with clients regarding their financial goals - both as proprietary and physical traders. Whatever you decide, we’ll be able to provide you with the tools and resources you need.

Are you looking to trade with proprietary assets or physical ones? For more information, contact PermuTrade today and we’ll make sure we’ll address any questions or concerns you may have.