Institutional and Retail Traders

There is a big difference in the way that a retail trader approaches the Forex or any other financial market from how a professional institutional trader will go about navigating them. What we mean by a retail trader is a person who typically trades from their homes and is not employed in the financial markets. An institutional trader would be someone who works at a hedge fund or an investment bank, think a corporate trader.

In this following Wiki, we will talk about the two different types of traders, what their differences are, and why you might want to consider trading and approaching the financial markets like one over the other.

Institutional and Retail Traders

Ok, so there is a pretty big difference in the way that a retail trader approaches the Forex or any other financial market from how a professional institutional trader will go about navigating them. What we mean by a retail trader is a person who typically trades from their homes and is not employed in the financial markets. An institutional trader would be someone who works at a hedge fund or an investment bank, think a corporate trader.

In this section, we will talk about the two different types of traders, what their differences are, and why you might want to consider trading and approaching the market like one over the other.

What is a Retail Trader?

The chances are that if you are reading this then you are probably a retail trader. Or maybe you are looking to become a trader and are you are doing a little bit of research before you dive in head first. This is by design because we created these Wikis specifically for the retail market. It would be a great compliment if institutional traders joined as well because there is definitely a ton of useful information found in these Wikis but our goal was always intended to help retail and home traders gain a glimpse into how the large funds and investment houses trade the Forex and other financial markets.

Retail traders are typically normal everyday people who have jobs outside of the financial markets. Sometimes they are small business owners but are looking for a way to make a little extra money in their spare time. For many retail traders, it is their goal is to become a full-time trader to enjoy the freedom and flexibility that comes along with what they perceive to be a trader’s lifestyle.

As far as the lifestyle goes you do need to be trading at certain times of the day to be a part of the best trading opportunities but you certainly can be anywhere in the world as long as you have a trading platform, laptop, and a stable internet connection.

Retail traders usually get their trading education by searching the internet for the latest and greatest system. Instagram has become a very popular place for "Gurus" to sell their lifestyle with flashy vacations and sports cars. These systems are selling the dream of making millions for a small one-time fee or maybe even a monthly subscription. Because retail traders mostly find their trading education online it’s almost inevitable that they start their career by utilizing some sort of technical analysis system that uses past price behaviour, indicators, or patterns to attempt to predict future price action. This is because the internet is flush full of gimmicky trading systems that promise the world and are all based on Technical Analysis.

If you do a quick Google search on trading education you will find all kinds of systems, gurus, algorithms, and indicators all promising that you will make boatloads of money with very little effort. Even if you do a search for hard-copy books you will no doubt find almost all of them focus on some form of Technical Analysis. It all seems to be the same or similar thing packaged up with different catchy names to get you to buy. The same goes for weekend seminars and webinars; they are almost all focussing on the same Technical Analysis stuff over and over with the only difference being how it’s being packaged and sold.

The reality is that the people selling these systems have likely never made any money as a trader. It’s very sad but it is probable that these gurus have only made money from selling you their trading-related products.

This is not to say that Technical Analysis products are the only subject out there related to trading. There absolutely are lots of great websites and books that focus on some of the other stuff that you need to know such as Trading psychology or Risk Management. However, this seems to be in the minority and can be difficult to find high-quality content. It’s almost impossible to find any information about trading fundamentals and sentiment that is geared toward the retail market. If you do find any fundamental information it’s likely that it is an academic study with no real practical application to day trading the financial markets. It’s also very difficult to get all the information you need to know in order to become successful all in one place.

The good news for you is that our Wikis will cover a vast array of the things you need to know in order to become a successful trader.

We will let you in on a secret that the marketing guys don’t know or have been hiding from you. We are pretty sure it’s because they don’t know. Trading is a skill where you need to learn many moving parts. It’s not enough to say that you are a pro when it comes to knowing everything about Technical Analysis because everyone knows Technical Analysis these days. That’s great if you are a walking encyclopedia of Technical Analysis but you are only proficient in one of the 5 subjects you need to be in order to become truly successful as a financial trader.

You need to become proficient with:

1. Fundamental Analysis.
2. Sentiment Analysis.
3. Risk Management.
4. Trading psychology.
5. Price Action Analysis
6. Technical Analysis.

The first 4 are the most important and should make up at least 80% of your trading while Technical Analysis only being of value as a timing tool for entry and exits. This is how the majority of institutional traders approach trading.

What we find really interesting is that retail traders typically use roughly 95% technical analysis in their trading with a tiny bit of Risk management and probably little to no proper Trading Psychology. Certainly, almost no retail traders are using fundamentals and sentiment analysis which are the actual reasons that prices move in the Forex market and other financial markets. We can say with the utmost conviction that prices do not move because of Technical Analysis or moving lines on a price chart. And we think that most people will agree if they are using any form of logic.

Do you think that maybe there is something to the statistic that 95% of retail traders fail and lose money overall? That is an incredibly sad statistic and we would say from our experiences that it’s probably a very conservative percentage. At the same time, these money-losing retail traders are using 95% technical analysis to guide their trading decision! Really think about that for a moment and let it sink in. 95% of retail traders fail and lose money over the long run while at the same time 95% of retail traders use Technical Analysis exclusively to make their trading decision. Isn’t that an amazing thought? 95% of retail traders lose money and the same 95% of retail traders use Technical Analysis systems to trade the market. This is about the time that you should have a light bulb go off in your head. If you didn’t just have an aha moment please read that paragraph again. The failure statistics of retail traders directly match up with the percentage of retail traders that use Technical Analysis.

What it all boils down to is that the main focus of retail traders is typically some sort of system that is based on close to 100% Technical Analysis. It could be a manual trading strategy or it could be some kind of algorithmic strategy but it’s definitely technical in nature.

What is an Institutional Trader?

An institutional trader is pretty much the exact opposite of a retail trader. An institutional trader is a trader that works for some kind of financial institution such as hedge funds, banks, investment banks, prop houses, pension funds, or any other type of money management firm. Said another way, these are corporate traders, not at-home traders as in the case of retail traders.

These traders will typically get an economics, math, MBA, or finance degree from a college or university before getting a job as a junior trader at a financial institution. Over time, as they gain more experience, they will learn how the largest traders in the world manage huge sums of money on behalf of the bank or their clients.

The institutional trader will typically start their career as a junior analyst and work their way up over the years to become a senior fund manager with billions under management. This process will typically take many years, if not decades, to be able to get to the point where the trader is competent enough to manage huge sums of money and pull an above-average return when compared to traditional asset classes such as stocks and bonds.

Their main focus is on the fundamental situation of economies. Much of their attention will be paid to the Central banks of each major nation that they monitor and the economic statistics coming out of their respective countries. They also pay strong attention to the current market sentiment, have a lot of strong Risk Management skills, keep up with a solid Trading psychology, and might use a tiny sliver of Technical Analysis thrown into the mix to help time an entry.

These players make up the largest portion of the trading volume making them the most influential traders in terms of price movements in the Forex and other financial markets. They have access to virtually unlimited amounts of capital in some situations.

Because these traders have access to so much money it highlights why we as retail traders should want to know how institutional traders think and trade. Doing this will offer us opportunities to jump in on their trades and let them move the market with their huge buying and selling pressure. This gives us a free ride along the way. Just imagine if you knew what information the largest institutional traders in the world were watching and how they might look to trade that information. You could literally just join them when the trade happens.

There are many institutional traders that are execution-only traders which means that they are taking orders from their clients rather than making them a profit. This is not the kind of institutional trader that we are referring to. We are talking about the ones managing the world’s money and controlling the price movements in the markets. We are only concerned with knowing what the real traders are thinking and how they intend to make a profit.

What is the difference between Institutional and Retail Traders?

The major difference is in "How" an institutional trader approaches the markets when compared to how a retail trader approaches the markets. The differences will become more apparent by drawing some comparisons.

The retail trader usually starts, and inevitably ends their trading career, by utilizing some sort of Technical Analysis system that uses past price behaviour, patterns, or indicators that attempt to predict future price action. This is in direct contrast to institutional traders who will almost never look at any sort of technical indicators or patterns to help give them an edge in their trading.

Professional traders focus on fundamentals and sentiment with strong attention paid to managing risks and keeping proper Trading psychology. Retail traders focus on technical systems, price patterns, and indicators while typically lacking sound Risk Management and good Trading psychology. The only reference a retail trader typically makes about Trading psychology is to blame their bad psychology as the reason they can’t make a profit. It’s a very typical thing for retail traders to blame the market for their losses rather than owning those losses. A lot of people have a hard time considering that they are the one that is actually wrong because it’s just easier to blame the broker or the market.

Institutional traders focus heavily on Risk Management and rarely use leverage. If they do use leverage they are very careful about not risking more on that particular trade than they would if they had not used any leverage at all. Retail traders look for Forex brokers that offer 200x, 500x, or even 1000x leveraged trading accounts. The idea the retail trader gets in their head is that if they really leverage up their trades they can turn something like $500 into $100,000 very quickly. While this is possible, it is doubtful that this new retail trader has the necessary skill and training to pull that off. They typically leverage up without considering that they might just lose their $500 a lot faster which is usually the case.

Retail traders are typically far too undercapitalized to make enough money to support their basic needs. This is what causes them to take excessive risks using way too much leverage. This kind of behaviour inevitably leads to poor Trading psychology and bad habits that become difficult to break. They miss the point that trading consistently in a professional manner while developing a proper track record is more important than making money. You can’t trade with money you are scared to lose and expect to make millions. That kind of pressure is too much for most people. Institutional traders are typically well-backed with capital and receive more capital as they continue to show consistency and improve their track record.

Institutional traders pay top dollar for the fastest news feeds and audio squawk services available. Examples of these are the two most well-known; the Bloomberg Terminal and Reuters Ikon. They do this in order to get market-moving news and information faster than their competition. Retail traders typically avoid news events and pay very little attention to Economic data releases because their trading patterns and technical systems fail during these times. This is a shame because some of the best trading opportunities happen right around these news events. But, you obviously need to know how to trade them.

Institutional traders focus heavily on developing and maintaining a healthy Trading psychology that keeps them razor-focused on the things that matter the most to their trading in real-time. Retail traders focus on systems that attempt to remove Trading psychology and hopefully have a win rate of 100%.

Are you starting to see the differences between a typical retail trader and institutional players? For the most part, they do pretty much the opposite of each other. And you also have to consider who actually makes money. We can tell you from experience on both sides that retail traders are overall net negative compared to institutional traders.

Why should Traders learn the Institutional Way of Trading?

Institutional traders are the masters of the universe when it comes to the Forex markets and other financial markets. They are responsible for the vast majority of price movements in the markets because they simply have control over the most money going into and out of the financial assets. As retail traders, we want to know what institutional traders are focussing on so that we can take advantage of the price swings they cause with their huge buy and sell orders. As a retail trader, you never want to be on the wrong side of the flow of institutional money because you will simply get run over. You would be foolish to think that you have a chance when a bus is barrelling at you 100 miles per hour. It’s best to step aside or get behind the bus and enjoy piggybacking while it clears the road for you.

This brings up an interesting observation that we have seen countless times watching new and experienced retail traders alike for decades. It’s absolutely crazy how often retail traders are on the wrong side of the fundamentals and sentiment. It's almost all the time. This is because most indicators and technical systems use past price information to try to predict future price direction with no regard for the actual reasons "WHY" the price is moving the way it is.

What we have noticed is that most of these indicators will tell you to buy when the price is “oversold”. But what does oversold actually mean? If there is a fundamentally bearish reason for the price to be going down then buying just because the indicator is saying the price is oversold makes absolutely no sense and puts you on the wrong side of heavy institutional selling. Your indicator is too dumb to know when the bottom is in. You’re probably going to get run over and you almost certainly do not have the skill to call the end of a fundamental move if you are using technical indicators. This is exactly why most retail traders are perpetually on the wrong side of the market. They are constantly buying at the times when the big boys and girls are selling. You simply are going to lose against the big guys most of the time. Sure you might get lucky from time to time and bank a few pips on some scalp trades against the fundamental move but over the long run being on the wrong side of the fundamentals and sentiment will keep your trading account in the red.

Let us give you an example of a good friend of the creator of this Wiki that highlights this kind of behaviour. He also happens to be an extremely successful businessperson. We will use the creator of this wiki's own words to highlight this story.

My friend will ping me from time to time telling me about some amazing scalp trade that he just banked 4 or 5 pips on. Apparently, I missed the greatest move ever.

First off, I could not care less about 4 or 5 pips. I regularly bank trades in excess of 50 to 100 pips or more as day trades. My personal record is over 1,000 pips on GBPJPY short trade during Brexit that lasted a couple of hours. I was doing this while all the technical traders were sitting on the sidelines watching the massive price moves and shaking in their boots. Yes, it takes guts to trade an event like Brexit but you need to be there for the best opportunities because they can sometimes make your month.

Back to my friend and his scalp trades. The conversation inevitably goes something like this:

Friend: I just banked 5 pips on a EURUSD trade, it was sweet pipskies. Me: Let me guess, you went long right? (Usually, I also put in that emoji that slaps itself in the face). Friend: Sure did! There was a textbook cup and handle on the 1-minute chart. Hit my take profit to the tick! Me: And now it’s 50 pips lower, you’re lucky you got out when you did or you would have gotten killed. You realize that the European Central Bank just announced a massive quantitative easing program today and that the price is going down in a straight line right? (Insert the emoji that smashes its head off a brick wall). Friend: Yeah I heard something about that. Me: So why would you take on so much risk and step in front of the falling knife like that? This thing will probably be down 1000 pips by the end of the month! Friend: I don’t understand that fundamental stuff you’re always talking about. Me: You should take the time to learn. I’ve been in and out of the EURUSD short today twice and booked a total of 180 pips with almost no drawdowns and no risk. Friend: Seems like too much work. I’ll stick with my cup and handle trades, they are easy money. Beers next week?

This kind of conversation happens all the time. What he is really saying is that price has gone down too much and that it can’t go down anymore. He is absolutely on the wrong side of the market every single time he makes a trade which makes the risk that he takes 100X greater than any trade I take. This is because I know the reasons the market is moving and let the big boys do all the hard work for me. I can also say when these tiny 5 pip scalp trades go wrong he will hold them for hundreds of pips offside. At the time of this writing he is currently holding a GBPUSD trade long from 1.4400 and thanks to Brexit the price is currently sitting at 1.2400. It doesn’t make a lot of sense to book 5 pip profits and hold trades 2000 pips offside but sadly a lot of people will do just that. You would need to make 400 profitable 5 pip trades to pay for that 1 2000 pip loss. That’s the same thing as saying you are going to be correct 99.95% of the time.

It may seem like I’m making fun of my friend but I’m not. He is a great person and definitely not the only person who thinks and trades like that. I have seen so many people trade this way in the Forex market. Fortunately for him, he has deep pockets and can hold positions 2000 pips offside. But his account is down huge overall and he has had to deposit more money on several occasions to support his margin requirements with the broker.

For most people, that kind of trading would have wiped out their trading account a long time ago. I really think it makes the case to learn the fundamentals. Also learning to trade for such a tiny amount of pips is probably a flawed idea because risk and reward just don’t add up with this idea. There are plenty of decent moves with lots of pips to be had every day, you just have to learn to sit in a trade and let it develop.

End of trader's story.

Understanding how institutional traders trade will give you a true understanding of why the price has moved the way it has and where it may go in the near future. This is what our job is as traders, picking where the currency pair will likely go soon and making some pips when it does. But we do it with the understanding that this is how the overall market is going to trade it based on the fundamentals.

If you are ever fortunate enough to stand around a water cooler at a hedge fund or an institutional trading floor you will get a dose of reality in what you hear the traders and money managers talking about. You will NEVER hear these professionals talking about how the MACD is showing positive divergence on the 512 tick chart with a bullish signal from the Ichimoku cloud or some other technical garble like that. What you would hear will directly contradict the majority of the rubbish courses that you will find all over the internet.

You will hear conversations about how low commodity demand from China is causing the Australian dollar to weaken or how one more positive CPI reading and the Federal Reserve will have no choice but to hike their benchmark interest rate at the next FOMC meeting. You will hear all kinds of banter on how they can position their trades ahead of the next key economic risk event.

Related Wikis

Readers of Institutional and Retail Traders also viewed:

• Essential Forex Trading Guide
• Pre-Trade Considerations
• Fundamental and Sentiment Trading Strategies
• Technical Trading Strategies
• Developing your Trading Process