May 5, 2020
There are different kinds of investors out there, and it might be a bit confusing when you are initially signing up with a broker. Understanding the difference between different kinds of investors is essential when considering an investment in any asset, stock, forex pair, or cryptocurrency. In simple terms:
An institutional investor is either an individual or an organization that invests on behalf of other people, while retail investors are normally non-professional individuals who trade securities and EFTs.
What is an institutional investor?
An institutional investor is a more sophisticated type of investor, such as:
- Mutual funds
- Hedge funds
- Commercial banks
- Pension funds
- Insurance companies
- Endowment funds
Institutional investors will normally purchase and sell significant amounts of bonds, shares as well as other securities. You may have heard the term ‘Wallstreet Whales’, which is quite representative of institutional investors.
Institutional investors are a more sophisticated group than an average retail investor; therefore, they are usually subject to fewer restrictions – for example, lower leverage caps. Institutional investors face fewer protective regulations than normal investors because it is assumed that they have more in-depth knowledge and are able to protect their funds more effectively.
Institutional investors will have the resources, experience as well as specialized tools that help them make investments. Their access to in-depth research as well as knowledgeable personnel allows them to scan various investment opportunities that are not available to the general public (aka retail investors). Institutional investors are said to move markets, as they are responsible for a big portion of transactions that take place in major exchanges, which means they influence supply and demand disparities that can result in unpredictable price fluctuations in bonds, securities, currency pairs as well as other assets.
Retail investors will pay attention to institutional investors’ actions to determine which securities they should buy since institutional investors are the ones who lead financial markets and influence prices.
What is a retail investor?
Probably, you yourself are a retail investor. A retail investor is defined by the FCA as an investor who “is not a professional client or an eligible counterparty.” Retail investors are individuals and market participants who are not (and were not) employed in the financial sector. They operate independently with the help of either traditional or online brokerage firms. Retails investors will purchase securities, mutual funds, bonds, EFTs, currency pairs as well as other assets and trade them in must smaller amounts, unlike institutional investors.
Retail investors are considered to be less knowledgeable and experienced, unlike institutional investors, and are prone to make more human errors or trade on emotion. This is why their trading is more protected by stronger regulations.
With brokerage firms’ help, retail investors can trade more comfortably but are still subject to a lot of risks despite being barred from high-risk, complex financial instruments. Trustworthy brokers will offer retail investors assistance through copy trading tools, trader’s education, EAs (expert advisors), or roboadvisors. Since retail trader has a lower purchasing power, they normally pay higher fees when trading, be that spreads or commissions, as well as other fees like account fees, withdrawal fees, etc.
Retail investors often struggle with a lack of discipline and expertise, resulting in loss of funds and have created a negative reputation for retail trading in the financial world. Despite that, retail traders are having a large impact on market sentiment. The overall attitude of investors on a particular security can heavily influence the financial market.
Retail investors now have more access to more financial information than ever, as well a trader’s education, tools, and mobile trading, which simplifies retail trading and makes it more attractive than ever.
Retail Investors vs. Institutional Investors
Both retail and institutional investors have access to various markets such as forex, commodities, options, bonds, futures, and stocks. However, due to some securities’ nature and the way transactions take place, some markets, like swaps and forward markets, are better situated for institutional investors rather than retail investors.
Institutional investors will normally buy and sell in block trades (10,000 shares or more), while retail invests with trade in lots (100 shares or more). Due to larger trade volumes, institutional investors will often avoid buying stocks from smaller companies. They will avoid buying a large percentage of a single company’s shares since this can violate the regulations.
“Most investors, both institutional and individual, will find that the best way to own common stocks (shares) is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) of the great majority of investment professionals.” – Warren Buffet.
Retail investors currently take up about 30% of the whole financial market and are commonly accused of making uninformed decisions and harmful speculative traders. Leverage is a crucial facilitator for speculative trading, which is why financial market regulators impose leverage limits on retail investors. This results in smaller losses with less harm to the market.