by Vicki Schmelzer
While only a small portion of the $5.1 trillion daily trading in foreign exchange is done by retail accounts, retail trading has grown steadily in the past years as Forex came to be considered an asset class. In its latest Triennial survey, the BIS estimates that of the $1.6 trillion of the daily spot turnover done in April 2016, just $60 billion was done by retail accounts.
This may sound small, but remember that back in April 2001, when total daily spot turnover was $387 billion, the entire “non-financial customers” section (where retail takes place) was $58.3 billion. In April 2016, all “non-financial customers” totaled $117 billion or 7% of all trades in the spot market. The New York Fed’s Foreign Exchange Committee volume survey released in 2016 shows that trading by volume “non-financial customers” in April 2016 was at roughly 7% of all FX trades.
The driving force behind retail trading is a desire to make money, exactly the same driving force behind investment bank trading. While retail traders and investment bank traders have the use of many of the same tools, the investment banker has several big advantages.
Investment banking offers a big salary but also big responsibility. The old adage that “you are only as good as your last trade,” rings true in the investment banking community. A trader can be a “hot shot” one year and out on his ear the next. There are countless stories of traders crashing and burning after a successful run. Nevertheless, being a trader at a large financial institution does have perks.
Aside from having larger position limits than any retail trader would have — tens of millions of dollars instead of tens of thousands, the investment banker has access to client flow information, which can help shape trading decisions. In addition, the sheer size of the some of the trades going through allows a trader at an investment bank to “piggy back” on a trade, offering another advantage.
As an example, the euro trader sees that bank client flow data has been showing a near-daily exodus out of the euro and has watched EUR/USD fall steadily from 1.1000 to 1.0700 during this time. Now, with the euro at 1.0725, the trader starts to see new client inflows back into the euro and decides to go long EUR/USD again.
Similarly, a USD/JPY trader gets a client order to buy $250 million at the current rate of 102.50. The trader expects the order to drive the USD/JPY price higher, so he buys a total of $270 million and then takes profit on the extra $20 million after the pair rises.
Such strategies are not always successful, but in terms of risk/reward, typically do result in a profit, or at least not a loss.
Another perk that the investment trader has that a retail trader does not is the ability to take a loss.
Say a trader has a sizable position in the currency market and something unforeseen takes place, such as a military coup or a natural disaster (like the earthquake and tsunami in Japan in 2011). A bank trader would not be fired because of losing money under these circumstances. In contrast, an event like this could wipe out a retail trader.
The retail trader has come a long way since the mid-1990’s when retail Forex trading really began to take off. Prior to that, anyone trading currencies for his own account had many things working against him, from not having an independent price data source, to being ripped off by the early brokers, and to not having access to the same kind of information that bank traders have.
Retail accounts should give thanks to Reuters, who introduced the Reuters Market Data Service (RMDS) in the early 1980’s. This was the precursor to the current Reuters dealing system. In the years that followed, electronic trading blossomed, not just at the big banks but also in the retail arena. Suddenly, every trader, big or small had access to the same narrow prices and, as the electric trading platforms began to include financial news feeds, they received breaking news at the same time. This took away some of the trading advantages of the investment bankers, although not the proprietary deal flow information.
In the modern world, the retail trader starts the day the same way as an investment bank trader. Both traders get up, look at current FX levels, interest rates, and commodity prices, read the economic and political news from overnight, and see how global stocks did, and then make decisions about where currency prices are likely to head in the upcoming session. As a practical matter, both trader types need to set the stop-loss and take-profit orders for the day and stiffen their spine to be disciplined in letting those orders be executed.
Tip: Do not envy the investment bank trader or bemoan being “only” a retail trader. A bank trader has constant pressure to produce profits every day from people he would not invite out for a beer. The retail trader has the luxury of simply not trading on a day when conditions are confusing and unclear. You do not have to take every trade — but the professional trader does.
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