by HSeldon2020
I was asked to write a post on this, so here you go:
Most people have an image in their heads when they hear the term “Institutional Trading” – it’s usually either an old white guy in a suit that looks like a combination between Mortimer and Randolph Duke from Trading Places, or a young white guy in a suit that looks like Leo DiCaprio from Wolf of Wall Street. They are typically pegged as amoral, with unfair advantages in life and trading. They might donate to charities for a tax write-off and at the same time step over you if you were dying in the street.
Not a pretty picture is it? The funny thing about this image is that it is simultaneously grotesque, and also aspirational for some people.
I am not going to argue whether or not that stereotype is close to the truth. The fact is I have met some of these “Masters of the Universe” and a few match this description, while others would be hard to differentiate from your neighbor.
One thing is certain – they are all wealthy. Notice I didn’t say rich, I said wealthy. Rich is the person who gets a big check, wealthy is the person that signed that check – there’s a difference.
So what are these Institutions? You have heard of the names I am sure – Blackrock, Vanguard, Fidelity, Ark, etc. But what are they really?
Imagine you are trading with a million dollars in your account. That’s a lot, right? You can make some pretty big trades with that – especially given the 4X Buying Power. Now imagine you have 99 other friends all with a million in their accounts as well. The 100 of you decide to get together and form a trading company. You each put your $1 million into the company trading account, and now have $100 million. At this point you probably would feel pretty damn powerful and ready to dominate the market – but the truth is you would barely qualify as an Institutional Trading firm. Perhaps a very small one.
That should give you a sense of how much money we are talking about here – even if you had a million and combined it with 99 other friends, you still wouldn’t even be a sub-division of a sub-division in one of these firms.
So what advantages do they have? Well, not so long ago the answer was – a lot.
They had access to real-time price movement, historical data, programs that could test strategies, run studies, and chart almost anything they wanted. They were able to place trades immediately and without delay, and did so with only marginal fees. These were huge advantages over the retail trader.
Now a 20 year old with an Ameritrade account pretty much has every single one of those things at their fingertips in the comfort of their own homes.
Does that mean things are now fair? Hell no – they never are – and never will be.
Think about it – If you were going to buy a new TV or even a new iPhone, you wouldn’t have much room to negotiate the price – you’re pretty much paying what they are listing it for, or walking away empty-handed. However, now imagine you walked into that store and said you want to buy 10,000 TV’s or 25,000 iPhones. At that point you certainly aren’t paying anywhere near the retail price, shipping is free, and you’ll have access to a number of upgrades that might not even be available to the public.
Same thing applies to stocks – if you trade a $30,000 account, Ameritrade is only going to go so far in knocking down those fees – if you trade a $300,000,000 account, well you’re naming your price.
IPO’s? Swaps? Yeah – they get first crack, and sometimes the only crack at it.
Taxes? I doubt many of you have off-shore accounts, tons of “phantom write-offs” and access to the top tax lawyers. But they do.
So yes, they have advantages – Some may argue that those advantages are necessary and reasonable (you spend a lot, you get a lot), others will cry foul. I can see the argument on both sides, but one thing is certain – they do have the advantage.
However – keep in mind that those advantages are highly regulated. In other words, it isn’t as easy as you think to just cheat the system. Congress, which ironically is the biggest perpetrator of using inside information, tends to make it a sport to crack down on these Institutions, especially around election time. And for the record – Inside Information means information that is not available to the public through any means. That last part is important. Because some information is available, but only for a price and that price could be astronomical – well outside the reach of the average trader. But because it is technically available, it is not considered Inside Information. This is one way to skirt that law – you make the information so hard to obtain that only the very wealthy can actually obtain it.
But that still doesn’t answer – what are these institutions?
In essence, they are trading, just like you are, except instead of trading an individual account they are trading on behalf of a company/corporation. Inside these Institutions you have Analysts and Operators. The Analysts are studying the technical and fundamental information, as well as the larger economic trends, and writing detailed reports. These reports, which can be hourly, daily, weekly or monthly are sent to the Operators who then use that information to make decisions on what, when and how much to trade.
One significant change in recent years has been that Analysts began to see the Operators as the “middle-person”, and started writing Algorithms that put their analysis into action. These algorithms would recognized patterns and act accordingly. It is so prominent now that almost 75-80% of all their trading is done through these Algorithms. Meaning the power within these Institutions shifted from Operators to Analysts. Now you have Analysts and Data Scientists directing the deployment of capital. Not surprisingly profits soared. And for those of you thinking, “Well then I should just use Algorithms to trade!” consider for a moment the amount of information, staff and trading power these companies wield. In fact, the very pattern you might be thinking of writing your algorithm to trade, is the same one their algorithm is trained to recognize and lead yours into a trap.
There are also different kinds of Institutional Trading Firms – the one that gets the most attention are Hedge Funds – Elliot Management, Citadel, etc.
Hedge fund managers generally have complete autonomy to trade what they want with their clients money. That freedom allows them to be flexible, creative, and yes – hedge. Even though they are what comes to mind for many retail traders, they only represent between 3-5% of the money going into the market at any one time. However, because they take risks, their capital tends to get deployed into equities that other funds would never touch. Hedge funds can move the price of PLTR or GME because they are trading those tickers in high volume.
The largest contributor of capital to the market are Mutual Funds, the boring distant cousin of Hedge Funds. Why do I say boring? Well, there is nothing boring about making billions of dollars – but they do so without very little freedom. They simply invest in what their clients direct them into, although they of course advise (which is what gives them the flexibility), but before the money is even transferred to their account it has already been decided where it should go and when.
Pension Funds which is basically the employee donated money that they expect to receive upon retirement, controls roughly 10% of all the cash in the market. Managers of Pension Funds have been historically plagued with a lot of accusations of corruption until the space got more regulated (this is an area the Mafia used to generate a lot of income back in the day). While they have more freedom than Mutual Funds, they cannot take the same risks as Hedge Funds. Still, when the market crashes, it not only takes out investors and those with wealth, it also wipes out many pensions that people were counting on.
Finally you have Investment Banks that act more as advisors or intermediaries – JP Morgan Chase, Goldman Sachs, etc. All of these firms write up extensive daily reports that help their clients move around their money into the best returns.
Finally – how does all of this matter to you – the Retail Trader? Because Institutions:
A) Know a lot more than you do
B) Move the market
C) Know a hell of a lot more than you do
That is why we follow the money.
Understanding what is and what isn’t institutional moves in a stock is essential in deciding which trades to make on the retail side.
Will they always get there first? Yes, of course. But getting there second, or even third, is still a very profitable strategy.
Hope this helps!
Best,
H.S.
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