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5c – Institutional Vs. Retail Traders

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5c - Institutional Vs. Retail Traders



Now that we know what the differences are between retail and institutional traders, it’s time to take a look at why you might want to choose a trading style that lines up a little more like the institutional traders style.  Of course the choice is up to you but institutional traders are the ones that dominate the Forex market, not retail traders.


In this Article

  •         Why should you learn the Institutional Way of Trading?
  •         It’s Tough Trading against the Institutional Flow of money
  •         Never Trade Against the Institutional Flow of money
  •         Get Inside the Mind of Institutional Traders


Why should you learn the Institutional Way of Trading?

Institutional traders are the masters of the universe when it comes to the Forex markets.  They have the most money and they make most of the money. 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 Forex market.

As retail traders we want to know what the institutional traders are focussing on so that we can take advantage of the price swings they create with their huge buy and sell orders.

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 even better, get behind the bus and enjoy the free ride while the big boys and girls clear the road for you.


It’s Tough Trading against the Institutional Flow of money

This brings up an interesting observation we have seen quite a lot watching new and experienced retail traders for over a decade.  It’s a bit unnerving just how often retail traders are on the wrong side of the fundamentals and sentiment driven flows of money. This is likely because most indicators and technical systems use past price information that 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 price is “oversold”.  But what does oversold actually mean? If there is a fundamentally bearish or negative reason for the price to be going down, then does buying because the indicator is saying price is “oversold” make the most sense?

This puts you are on the wrong side of the heavy institutional selling.  The chances are pretty high that you might get run over. Of course, if there is no fundamental or sentiment driven reason to be selling and price is just having a natural pullback then buying when an indicator is oversold might work out.  This is where understanding how fundamentals and sentiment work will help you make a better trading decision if you are using overbought oversold indicators for your trade entries.

Over the long run, trading against the fundamental and sentiment driven flows will cost you a lot more pips than it will make you.


Brandon’s Personal Story Time

Let me give you an example of a good friend of mine that highlights this kind of behaviour of being on the wrong side of the fundamental and sentiment driven flows.  

My friend happens to be an extremely successful business person.  He 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 do not trade for 4 or 5 pips, nor do I see the point.  It’s too much risk for me because your stop losses are going to have to be much more than 4 or 5 pips.  If you can scratch out a living banking 4 or 5 pips then good on you but I think most people would struggle over the long run with this kind of approach.  You would need to have a win rate above 90% to make this work. That is really tough to do. I prefer to shoot 30 pips as a minimum for day trades.

Back to my friend and his scalp trades.  The text chat conversation over Skype 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 banked 180 pips with almost no drawdowns.

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 when he steps in front of the falling knife 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 smart money 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 currency is moving and I’m happy to let the big boys and girls do all the hard work and push price for me.

I can also say when these tiny 5 pip scalp trades go wrong he will hold them for hundreds of pips offside.  It doesn’t make a lot of sense to book 5 pip profits and hold trades 200 pips offside but this is what a lot of people do.  You would need to make 40 profitable 5 pip winning trades to pay for that one 200 pip loss. That’s the same thing as saying you are going to be correct 97.5% of time!  That is really difficult to do.

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. I mean, people love booking pips quickly, it’s human nature.

Get Inside the Mind of Institutional Traders

Understanding how institutional trader’s trade will give you a true understanding of why 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 make 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 and sentiment.

If you are ever fortunate enough to stand around a water cooler at a hedge fund or an institutional trading floor you will you might be surprised at what you hear traders talking about.  You will likely 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 chat like that.     

You will hear conversations about how weak commodity demand from China is causing the Australian dollar to weaken.  Or you might hear 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.  This is true because Brandon has lived it and worked as an institutional trader in the past. We also have deep connections with some really powerful traders in the city.

But don’t take our word for it, go get a job at a large macro hedge fund and learn for yourself!  Honestly, this is a great idea because you get to earn a paycheck and learn some amazing stuff in the process.  This can only be helpful on your pursuit to Forex market domination!

By the time that you are done going through this guide you will have a firm grasp of how institutional money managers think about the Forex market and how they trade it profitably.  Try to keep an open mind with this information. It might contradict what you have been taught in the past but trading is a business of constant and never ending improvement so embracing this new way of thinking is a positive thing.  Worst case scenario you learn some new info.


Up Next:

Up next, we take a look at what we are actually doing as traders in this exiting world of Forex trading.  Some people think it’s a dirty word but you will soon discover why it’s actually a beautiful thing.


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