Retail vs. Institutional Traders
Individual traders, like you and I, are called retail traders
. We can be part-time traders, or full-time traders, but we’re not working for a firm and we’re not managing other people’s money. We retail traders are a small percentage of the volume in the market. On the other hand, there are the so-called institutional traders
such as Wall Street investment banks, proprietary trading firms (called prop traders), mutual funds and hedge funds. Most of their trading is based on sophisticated computer algorithms and high frequency trading. Rarely is any human involved in the day trading operations of these large accounts. Through whatever means, institutional traders have considerable money behind them and they can be very aggressive.
You may correctly ask, “How can an individual trader, like you and me, coming later to the game, compete against institutional traders and win?
”
Individual traders have a tremendous advantage over institutional traders. Banks and other institutions
are compelled to trade, often in large volumes, and sometimes with little regard to price. They are expected to be constantly active in the market. Individual traders, on the other hand, can decide whether or not they want to trade, and they can bide their time until opportunities present themselves.
Ironically, large numbers of individual traders miss out on their advantage by overtrading. Instead of being patient and exercising the self-discipline of winners, they succumb to greed, trade unwisely and unnecessarily, and become losers.
I always use the analogy of retail day trading and guerrilla warfare. Guerrilla warfare is an irregular approach to warfare in which a small group of combatants, such as paramilitary personnel or armed civilians, use hit-and-run tactics like ambushes, sabotage, raids and petty warfare to maneuver around a larger and less-mobile traditional military force. The United States military is considered to be one of the most formidable fighting forces in the world. However, they suffered significantly as a result of jungle warfare tactics used against them in North Vietnam. Earlier examples include the European resistance movements which fought against Nazi Germany during World War Two.
In guerrilla trading, as the term suggests, you are in hiding, waiting for an opportunity to move in and out of the financial jungle in a short period of time to generate quick profits while keeping your risk to a minimum. You don’t want to defeat or outsmart investment
banks. You are simply waiting for an opportunity to reach your daily profit target.
As a retail day trader, you have another distinct advantage over institutional traders in that you can exit your losing positions quickly. As I will discuss later, you must determine your exit plan if a stock trades against you. A new trader should start with trading one standard lot, 100 shares. One hundred shares is low risk, and although it’s also a low reward for the trader, you need to start somewhere. New traders should start out with trading 100 shares. If their stop loss hits, they really have no excuse about why they couldn’t get out. Even for an illiquid stock (a stock that is hard to sell) that is traded with very low volume, 100 shares is nothing.
Institutional traders, on the other hand, may have a 1,000,000 share position with which to work. It takes some time to unravel such a large position, not one click of a mouse (or in the case of most active day traders, a tap of a Hotkey, exceedingly faster than clicking a mouse), and losses can be significant. Day traders trade with much smaller size and can get out of their losing trade for a very small loss. In fact, a good day trader can take numerous losses of as little as one penny. So you must learn to exploit one of your huge advantages. And this means stopping out a stock when it trades against your exit price.
As a day trader, you profit from volatility in the stock market, which is more apt to occur in morning
trading than later in the day. If the market or stock prices are not moving much, you most likely are not going to make any money; only high frequency traders make money under these circumstances as they have access to low commissions and can trade large volumes of shares with low fees. Therefore, you need to find stocks that move to the upside or to the downside. Not every move of a stock’s price is tradeable or even recognizable by traders. The job of a good trader is to find recognizable and consistent patterns that you know from the past and then trade them. There are many “big” moves in the market, and most traders think they should be doing their best to catch and trade every single one of them. That is a mistake. Your job as a trader is to stick to consistent patterns that have earned your trust because of their past performance. Institutional traders, on the other hand, are trading with very high frequency and will profit from very small movements of price, or as it is sometimes called, from “choppy price action”.
It is extremely important to stay away from stocks that are being heavily traded by institutional traders. As an individual retail day trader, you must stick to your retail trading territory. You will not trade stocks that other retail traders are not trading or not seeing. The strength of retail day trading strategies is that other retail traders are also using them. The more traders using these strategies, the better they will work. As more people recognize the line in the sand, more people will be buying at that point. This, of course, means the stock will move up faster. The more buyers, the quicker
it will move. This is why many traders are happy to share their day trading strategies. It not only helps other traders to become more profitable, but it also increases the number of traders who are using these strategies. There is no benefit in hiding these methods or keeping them secret.