from: http://www.wallstreetoasis.com/forums/principal-vs-prop-trading
Technically speaking, a proprietary trader’s primary purpose (99%) is to seek profit potential for the firms account INDEPENDENTLY of the commission/spread based trading that defines the flow and main focus of principal traders (75+%). That is, their profits and positions are driven by the success of proprietary trade ideas/models and NOT by arbitrage and re-positioning around client driven trade execution.
Most trading positions found on the sell side – aka the principal trader – also take some proprietary risk though, except that it is commonly referred to as “principal risk”. This refers to the direct market exposure the firm’s account takes by being on the other side of a transaction with a client (unlike an agency transaction where the firm takes no risk and only charges the client a fee for its services). The amount of proprietary/principal risk on a principal trading desk varies by firm and product. The bulk of principal trading always involves transactions with clients and the earning of spread/commission, but rarely in my experience is a desk perfectly hedged (ie, it normally has some risk exposure, like choosing to stay long after buying assets from a client) and often some desks take outright positions in products because they have views based on their information flow (customer, volume, research). I would say my desk is 85% principal 15% proprietary trading.
The reason I think these two main trading roles get confused is that clearly in both types of trading the firm has exposure to PnL. The difference is that in proprietary trading it is the purpose of the business (you have an idea, you risk the firms capital on it), and also, prop desks often trade multiple products. Vs principal trading, where exposure is a primarily a byproduct of the business (you can’t take the other side of a clients trades to earn a spread w/o having exposure – however temporarily) but is also an option for the business (trader liking the market and choosing to be net long his product) — with this later part being very much like prop trading, except limited to the specific product expertise of the trader.
