What is a Retail Options Trader?

There are so many different ways to trade, many different markets, financial instruments with different amounts of risk and reward. Regardless of how, what, and why you trade, it is important to understand the differences and similarities between being a retail trader versus an institutional trader. The differences are very important as the approaches to the markets are different. A retail trader will manage risk and entries based on what is appropriate to his/her account size, and my guess is that most of you aren’t managing a multi million dollar account of your own…and least not yet… Knowing how to approach the markets in a way that bests suits you will produce the best results in the market over the long term. Identifying some of the differences will help you know what trade set ups and market analysis will be most beneficial for you.

Are you a Retail Trader or an Institutional Trader?

When you trade for yourself and manage your own assets, you are considered a retail trader. Essentially, you are trading with your own money and placing trades through your own account held at a brokerage or bank. Trading set ups and market analysis should be tailored to your retail needs, which are, different from an institutional traders’ goals (albeit, you both want to make money as your primary objective). Trade commissions, account size, profit targets, time horizon, and risk management are just a few of the qualities that will differentiate a retail trader in the market. While we all might be trading with each other, our trades should be based on our own objectives that align with a trading plan that is appropriate for retail trading.

Historically Speaking

The ability for retail trader to access the markets with the same speed and accuracy is a relatively new experience. Some trading platforms for retail traders had begun to emerge in the 1990’s but it seems that most retail traders began using online platforms to trade for themselves in the 2000’s. Thanks to the speed and growth of technology, retail traders now have the ability to be as active in the markets as they would like. At any time they could be trading (unbeknownst to them) with a large hedge fund, a market maker, or a fellow retail trader.

With a click of a button from our mobile phone, computer or tablet, we can interface with a trading platform without ever needing to consult with anyone else. Online brokerages have opened the door to retail traders and more and more retail traders are trading actively. Retail traders have access to the same markets as institutional traders which has also meant that retail traders can trade more sophisticated trade set ups.

According to the CME, “Due to the increasing sophistication of active "retail" traders, CME has also been successful in attracting more active retail business.” Even the exchanges themselves differentiate the retail trader from an institutional trader. Source: www.cmegroup.com

Most reports and statistics lump all investors that do not trade as an institutional in to the very broad “Household Trader” category, only making the distinction between taxable and non-taxable (IRA type accounts). A vast majority of “Household” traders trade very infrequently. A Department of Labor Study from Nov 30, 2015 titled “Brokerage Accounts in the United States” showed that 80% of Households that own brokerage accounts placed less than 11 trades per year and only 4% made over 100 trades per year.

The active retail trader market is small and very different from the broad group of people who own brokerage accounts and only place a handful of trades each year. However they are usually spoken about and lumped in to the same category. The same study shows that more people are investing for themselves and relying on brokers less. 35% of households with brokerage accounts relied on brokers advice in 2001 down to 27% in 2013. DIY investing is being relied upon by more and more households further strengthening the active retail trader movement. So now that you are a sophisticated active retail trader, and have access to the information and systems that most institutional traders do, can you replicate the strategies that institutional traders do?

Trade Strategy

It is important to keep in mind that a strategy that might work well for an institutional trader won’t necessarily be the best strategy for you, as a retail trader. For example an institutional trader may be adding to a losing position with an outlook of averaging down or holding a trade for months on end, while a retail trader who may choose this strategy will most likely run out of capital before they can make money in the trade. Another important difference is that most banks and fund companies have sources of new capital to cover most losses while retail traders do not. These Institutional traders are able to cover most losses until their trading premise becomes correct. Typical retail investors typically risk too much in comparison to their ability co generate new income to cover losses. Bottom line is that Institutional traders have the capital to place trades until they get it right. There is much more pressure on the retail trader to get is 100% each and every trade, which is not realistic and causes many of the trading pit-falls that retail traders fall into. Retail traders and Institutional traders can trade using the same strategies, including multi leg strategies, but most likely the contract size a retail trader is trading with will be much smaller. Another key difference is that a retail trader is trading with the money they have worked hard to earn, where an Institutional is trading money that is at least 1 or two steps removed from their personal wealth. I believe this is an important psychological component for retail traders to consider. Despite many differences retail traders do have access to the strategies and technology that Institutional traders do. Based on their knowledge and experience in the market, with the right trading level, a retail trader can trade anything that an institutional can theoretically. Just because you can doesn’t mean that you should.

Should Retail Traders be trading the same way?

Even though retail traders CAN trade like an institutional trader, I’m not sure they should be. As a retail trader, one of the largest influencers of your trades will be the commissions you have to pay. It doesn’t make sense to take the risk of a trade and once commissions are paid on that trade, be left with pennies of profits, or worse off, a negative sum after commissions and losses. While brokers may give you access to all sorts of trading abilities, it is important for a retail trader to focus their trades on set ups that are most appropriate for them.

Don't forget that for every trade you place, you need to consider whether the risk and pay out will be worthwhile after the commission you, as a retail trader will need to pay. -Sarah Potter

I believe that retail traders should be learning and mentored by someone who is also a retail trader because the strategies and analysis will be much more closely related to the trades you can actually trade. Let’s face it, an institutional trader can get in and out of trades all day and not need to necessarily worry about the costs of placing the trades itself. So, just because someone was a market maker, or was an institutional trader in the past, it doesn’t mean those trade set ups will be appropriate for a retail trader. Don’t forget that for every trade you place, you need to consider whether the risk and pay out will be worthwhile after the commission you, as a retail trader will need to pay. We all want to grow our capital but we must do so responsibly and objectively. Objectivity and following a plan while removing emotion are skills that we can learn from Institutional traders, treat what you are doing seriously like a job, create limits and goals and write down your plan. Most importantly follow it! Manage risk at all costs, hope is not a plan. Know what you can make an lose on each trade and stick to those limits, do not trade too big for your account, because unlike the Institutional trader you mostly like will have to work really long hours to replace your capital.

What Should Retail Traders Do?

Every trader needs a plan, something that is tailored to the account size you are trading with, and the goals you have. Retail traders should set both long term and short term goals, and especially profit targets for both individual trades, and the monthly targets to achieve, but you need to balance the amount of trades with the opportunity costs of you spending time in front of the screens looking for trades as well as the price you need to pay for commissions, and your drawdowns (after all, there will be trades that wont work out).

"What I have learned is most helpful for retail traders when it comes to trades is that the probability of success of a trade is very important." -Sarah Potter

As a professional retail trader with years of experience in the markets and meeting many individual traders at public events, I would strongly suggest that it is important to learn from, and be mentored by someone who comes from the same perspective. Be cautious of placing trades that have too much risk and consider the probability of success. You want to choose trade set ups that will actually achieve profits for you on a regular basis, as opposed to a needle in a haystack. There are many trades setting up every day, make sure you are choosing trades that are appropriate for you and are high probability.

Retail traders are more sophisticated than ever, no longer should retail trader be used as a term to define a less sophisticated institutional trader. Retail traders are a group of traders in their own right, with complex strategies, sophisticated technology and market savvy reserved previously only for those professionals in the industry.

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