If you lose money on a funded account provided by a prop firm, you will either need to buy a new funded account from them, or if you violated their rules, you may be permanently banned from getting a new account. You will not need to pay them back.

Losing Money on a Funded Account 

Most proprietary trading firms offer two types of accounts: Demo accounts and Live accounts (may hold virtual funds). 

Traders trade in the demo account using virtual funds during the evaluation phase. Losses made in the evaluation phase are not real losses since trading is done with virtual funds. Once traders pass the evaluation, they get funded and begin trading on the funded account.

While losses are common in trading (90% of traders lose money), with prop trading, the trader is not liable for the capital provided. This means that losses made during trades are not the responsibility of the trader; the prop firm is responsible for covering the losses.

That said, prop firms have strict rules for traders. These rules are in place to maintain trading consistency and protect the proprietary trading firm's investments. In most cases, losing a percentage of money on an evaluation account leads to failure of the evaluation stage. The trader will have to restart the evaluation process.

With funded accounts, losing money has more consequences. These consequences are measures implemented by the prop firm to prevent traders from making reckless trades. Below is a breakdown of the consequences of losing money on a funded account:

Drawdown Limits 

The drawdown limit refers to the maximum allowable decrease in a trading account. The drawdown limit is often a percentage of the initial account value. Proprietary trading firms use drawdown limits as a check against excessive losses to prevent trading accounts from being entirely wiped out.

Drawdown limits vary by prop firms. While most proprietary trading firms have a fixed drawdown limit, a few offer flexible drawdown limits.

For example, a drawdown limit of 5% on a $100,000 account means you can’t lose more than 5% of the initial capital. If your account loses more than 5%, you will be penalized.

Some prop firms divide drawdown limits into daily losses and overall account losses. With IC Funded, for example, you can’t lose more than 5% of the previous day’s balance in one day. This means that there is a fixed daily drawdown limit and a cumulative drawdown limit. If the daily drawdown limit is exceeded, trading on the account is suspended for the day. But if the total drawdown limit is exceeded, the account will be closed.

The more losses you make while trading, the higher the chances of exceeding the daily and total drawdown limit. Consequences of exceeding the drawdown limit include margin calls, clawback, failure of evaluation, and funded account closure.

Split Reduction 

The split refers to the sharing arrangement between the trader and the prop firm regarding the returns generated while trading with the funded account.

The split ratio for prop firms varies depending on various factors, including the type of funded account, experience level, and in some cases, the negotiation skills of the trader.

That said, the average share of returns traders get is between 60% to 80%. Some prop firms offer as high as 90%.

While the split may vary, most firms use a performance-based sharing structure. Traders can unlock a higher sharing percentage if they make trades with minimal losses and better results.

Some prop trading firms have clawback provisions. If a trader recovers after consistently losing, the prop firm can take a portion of the gains to cover the losses generated from previous trades.

Re-qualification/Retake Evaluation Challenges

Most prop trading firms offer an evaluation phase. The goal of the evaluation phase is to test the ability of new traders to make consistent returns and manage risk.

Trading in the evaluation phase is done with a demo account using virtual funds. This reduces the risk of loss on bad trades for the firm.

Qualified traders must align with the firm's tolerance and performance expectations. Traders that fail the evaluation phase will not get funded accounts. Also, traders who make huge losses may need to restart the evaluation phase.

With some prop trading firms, this applies to traders with funded accounts. Whether the trader can repeat the evaluation depends on the prop firm's policy and the severity of the losses incurred.

Losses that could result in the need to restart the evaluation phase include exceeding the total drawdown limit and failure to meet performance targets.

Some prop trading firms offer traders a second chance to retake the evaluation with a fee.

That said, some firms may assess traders' performance and losses on a case-by-case basis to determine if the losses were due to isolated incidents or a lack of skills.

If the trader's overall trading strategy shows potential, the firm may allow the trader to restart the evaluation phase without a fee. That said, this is strictly at the firm's discretion and based on the firm's policy. 

Account Closure 

One of the major consequences of losing money in prop trading is account closure (including funded accounts). When the trader's losses breach the drawdown limit or prevent the trader from reaching the target, the prop firm can decide to terminate the trader's participation in the challenge.

If a trader keeps making losses, the prop firm considers it proof that the trader lacks the skills to make consistent trades. This is undesirable to the firm, especially since they want a team of traders who can make consistent returns with minimal loss.

After account closure, some prop firms offer traders the ability to reapply and start from the evaluation phase.

Some prop firms, however, do not give a second chance after account closure. The trader will not be allowed to restart the evaluation phase. This is dependent on the policy of the prop trading firm involved.

Do you have to Pay a Prop Firm Back?

Traders do not have to pay prop firms back for losses while trading on evaluation or funded accounts. The prop firm is solely responsible for all losses made.

Losses made in the evaluation phase are not actual losses because trading is done with a demo account. However, losses made with the funded account can affect the prop firm's performance. This is why most prop firms have strict drawdown limits, among other measures, to prevent excessive losses.

The only money traders pay to prop firms is the evaluation fee or subscription fee (where applicable).

That said, some prop firms have clawback provisions that enable the prop firm to take a portion of the trader's gains to cover losses made with previous trades.

Risk Management Strategies to Mitigate Losses 

While prop trading offers the potential for high rewards, it involves some risks. It is, therefore, best to have the skills and strategies needed to mitigate loss.

The best way to reduce loss in prop trading is to have risk management strategies in place. Risk management strategies are beneficial to both the prop firm and the trader. Benefits of risk management strategies include the protection of the firm's capital from a devastating loss, ensuring sustainability during inevitable losses, and optimizing trading outcomes.

That said, risk management strategies do not prevent losses; losses are inevitable due to the unpredictability of the market. Risk management strategies help to control and minimize losses.

Let's take a look at some recommended risk management practices:

Stop-Loss Orders  

Stop-loss orders are vital in reducing the potential losses on any trade. With stop-loss orders, traders can take controlled risks by defining the amount of money they can lose on a particular trade. Once the loss on a trade reaches a predetermined level, the stop-loss order is triggered, and the position is automatically closed.

Stop-loss orders prevent excessive losses that could wipe out an entire account and eliminate human emotions in trading.

In volatile markets, stop-loss orders are not foolproof. Price fluctuations can trigger a stop-loss even if the overall trend is favorable.

Position Sizing (Lot Size) 

Position sizing determines the appropriate amount to allocate for each trade. This helps traders to control their exposure to potential losses. It is determined by the account size and risk tolerance.

While position sizing does not directly prevent loss, it protects the trading account capital for the long haul. It ensures that a single bad trade does not wipe out the trading account.

Position sizing also prevents traders from quickly exceeding the prop firm's drawdown limit. By reducing the trading amount, traders can reduce the amount of money lost in individual trades, preventing the trader from exceeding the drawdown limit with a single trade and risking account closure.

Risk-Reward Ratio 

The risk-reward ratio measures the potential outcome relative to the potential loss on a trade.

This is usually expressed as a ratio. For example, 2:1, 1:3, or 1:1. The first number represents the potential outcome, while the second represents the potential loss.

A ratio greater than 1 (e.g., 2:1) indicates that the potential outcome is higher than the risk, which means the trader will benefit if the trade goes as planned.

A ratio less than 1 (e.g., 1:3) indicates that the potential loss is greater than the expected outcome.

A ratio of 1:1 means that the potential outcome and loss are equal.

While the risk-reward ratio does not directly prevent loss, it enables traders to assess potential trades (potential outcomes & losses) and make informed decisions that can help maximize the result and minimize the risk of losing money.

With a risk-reward ratio, traders can analyze entry and exit points before initiating trades. This prevents traders from making impulsive trading decisions based on emotions like greed and fear.

Conclusion

Prop trading is rewarding but risky, especially if the trader is inexperienced.

While traders do not invest their own money and are not responsible for the losses incurred during trading, there are several consequences to losing money while prop trading, including account closure, evaluation failure, and split reduction.

To be a successful trader, you need to learn how to make better trades.It is, therefore, best to improve your trading skills using the educational resources available on IC Funded to improve your trading before you start your funded trader career.