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Prior to the development of forex trading platforms in the late 90s, forex trading was restricted to large financial institutions. It was the development of the internet, trading software, and forex brokers allowing trading on margins, that started the growth of retail trading. Today, traders are able to trade spot currencies with market makers on margin. This means they need to put down only a small percentage of the trade size and can buy and sell currencies in seconds.
History
The year 1996 saw the first generation of forex online trading platforms. Web technology not only allowed retail foreign exchange trading to foster easy and fast ways for customers to access the markets, but also currency pairs while making trades from their own computers.
The software development of trading platforms has seen a number of stages. Initially, trading platforms were based on basic programs downloaded to computers. This was followed by the development of easier-to-use interfaces and advanced features such as charting and technical analysis tools. The next stage saw the move to web-based platforms and mobile devices such as tablets and smartphones. Since 2010, there has also been a focus on developments to integrate automated trading tools and social trading into the forex trading platforms.
Regulation
In recent years, financial regulators in developed markets have introduced measures to limit the amount of leverage that retail investors can take on, particularly across foreign exchange transactions. These restrictions sought to limit speculation and protect retail investors against unexpected losses.
USA
In the United States, the Commodity Futures Trading Commission (CFTC) limits leverage available to retail forex traders to 50:1 on major currency pairs and 20:1 for all others. Major currencies include the Australian dollar, the British pound, the Canadian dollar, the Danish Krone, the euro, the Japanese yen, the New Zealand dollar, the Norwegian Krone, the Swedish Krona, the Swiss franc and the US dollar. The National Futures Association (NFA) is authorized to periodically review the list of major currencies, in light of changes in volatility.
The initial version of the CFTC's 2010 regulations proposed lowering leverage limits to 10:1. But the CFTC adopted the higher 50:1 and 20:1 leverage limits described following criticism from Forex market participants. No such restrictions existed prior to 2010, when these rules came into effect.
EU
In Europe, the European Securities and Markets Agency (ESMA) caps the amount of leverage that brokers and CFD providers can offer retail investors. These limits, which came into effect in 2018, vary between 30:1 and just 2:1, depending on the asset class. More volatile asset classes, like crypto-currencies, tend to attract lower limits.
ESMA’s limits on leverage are as follows:
- 30:1 for major currency pairs;
- 20:1 for non-major currency pairs, gold and major equity indices;
- 10:1 for commodities other than gold and non-major equity indices;
- 5:1 for individual equities and other reference values;
- 2:1 for crypto-currencies.
ESMA's major currency pairs comprise any two of the following currencies: the US dollar, the euro, the Japanese yen, the pound sterling, the Canadian dollar or the Swiss franc. All other currencies are deemed non-major.
ESMA's major indices are any of the following equity indices: FTSE 100, CAC 40, DAX30, DJIA, S&P 500, NASDAQ, NASDAQ 100, Nikkei 225, ASX 200, EURO STOXX 50. All other indices are deemed non-major.
UK
The UK's Financial Conduct Authority (FCA) onshored SEAN's restrictions on leverage in 2019. This means that ESMA's measures outlined above became part of UK domestic law when the UK left the EU. These measures remain in place to this day.
Japan
In Japan, the Financial Services Agency (FSA) restricted leverage available to retail traders across foreign exchange transactions as early as 2010. Maximum leverage was capped at 50:1 in August 2010, and was subsequently reduced to 25:1 in August 2011.
Fraud
Retail forex trading has been promoted by some as an easy way to make profits and has thus been the focus for a number of foreign exchange frauds. In response, financial regulations in a number of countries have introduced restrictions or provided warnings about this type of trading as well as legal actions against perpetrators. However, due to the decentralized nature of currency trading and the easy global access to the internet, a number of brokers are based in less restrictive jurisdictions.
The retail Forex market became very popular after the development of the online trading technologies. Millions of new traders are attracted to Forex each year. They try to earn profits by trading the currencies, developing the new intraday strategies, and gaining on the long-term trends. But why does the retail FX market exist? Is it only a way to earn money for the brokers and some lucky traders? Here is the list of some functions — obvious and not — that are performed by the retail Forex market:
Earning opportunity — this is probably the most popular, obvious, and important function of the retail Forex market. It provides the earning opportunity to traders, brokers, affiliates, webmasters, marketing companies, and a lot of other online industries. Without a promise of profits, the retail Forex market would be limited to a simple exchange of the physical or current-account cash.
Extra liquidity — this is definitely a positive function of the retail currency market. Although not many traders use huge amounts of capital in Forex, the total sum of the money provided by the retail customers adds a good chunk of liquidity to the Forex market.
Extra volatility — a not very positive function at a first glance. The retail Forex market makes the rate movement less smooth and more volatile as traders prefer short-term positions. This leads to sharp reaction on the daily news and technical signals. Excess volatility is bad for the long-term traders, but it can be good for those who know how to benefit from such markets.
Social function — many communities were formed around Forex trading. Traders prefer to get help from other traders and they also like to share the knowledge related to Forex.
Technical strategy development — popularity of Forex trading, and especially the online and automated versions of such trading, led to the creation of thousands of automated trading strategies. Based on technical analysis, some of such strategies can be applied not only to Forex trading but in many other industries.
Of course, this list cannot be considered as an exhaustive one, but these functions are the main attributes of the modern retail FX market in my opinion.
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Institutional foreign exchange trading on the other hand, consists of the purchases and sales of financial assets by institutions through their traders. This definition of institutional trading applies to institutional equity trading, institutional stock trading, institutional options trading - any subcategory.
Institutional foreign exchange trading is practised by large companies that have teams divided into analysts and operators in such a way that the former are dedicated to making technical and fundamental analysis and the latter study the information and put into practice the strategies and operations that they consider most convenient.
To do this, institutional trading involves large amounts of money, which allows traders to have a great capacity to diversify their investments to avoid large losses.
In addition, by operating with large volumes of operations, traders in institutional trading have access to better prices in the market and can even directly influence the price movement of the assets they exchange. In fact, a battle is being fought among institutional traders to try to control the market and drive it towards their interests. The impact of institutional trading on stock prices can be substantial.
How do they get this control? If they believe a market is going to rise, they enter long, as any retail trader would, but by entering with large amounts of capital they can influence the confirmation of that trend.
Several advantages institutional trading once enjoyed over retail investing have dissipated. The accessibility of sophisticated online brokerages, the ability to negotiate trading fees, trading in and receiving more diverse securities, real-time data, the guarantee of best price and execution, and the widespread availability of investment data and analysis have narrowed the gap.
- Institutional trading involves, buying and selling of securities for account managing for a group or other institution, trading in larger sizes and can be trading in more exotic products.
- Online brokerages and other factors have narrowed the gap between institutional and retail trading, which once gave institutional traders an advantage.
More so, institutional traders have the ability to invest in securities that generally are not available to retail traders, such as forwards and swaps. The complex nature and types of transactions typically discourage or prohibit individual traders. Also, institutional traders often are solicited for investments in IPOs.
Institutional traders usually trade blocks of at least 10,000 shares and can minimize costs by sending trades through to the exchanges independently or through an intermediary.
Institutional traders negotiate basis point fees for each transaction and require the best price and execution. They are not charged marketing or distribution expense ratios.
Because of the large volumes, institutional trading can greatly impact the share prices of a securities. For this reason, they sometimes may split trades among various brokers or over time in order to not make a material impact.
The larger the institutional fund, the higher the market cap institutional traders tend to own. It is more difficult to put a lot of cash to work in smaller-cap stocks because the traders may not want to be majority owners or decrease liquidity to the point where there may be no one to take the other side of the trade.
Though, the cost to make trades might be higher for retail traders if they go through a broker that charges a flat fee per trade in addition to marketing and distribution costs. The number of shares traded by retail traders usually is too few to impact the price of the security. Unlike institutional traders, retail traders are more likely to invest in small-cap stocks because they can have lower price points, allowing them to buy many different securities in an adequate number of shares to achieve a diversified portfolio.
Conclusion
However, retail trading and institutional trading are different types of trading activities, retail trading often can lead to institutional trading. A retail trader may start to trade for their own personal account, and if they perform well, they may start to trade for friends and family. If a retail trader continues to generate positive returns and accumulate more capital from other investors, they may organize into what is essentially a small investment fund. This growth can continue, limitless, to the point where the retail trader is now an institutional trader.
Now, you know the difference between institutional trading and retail trading.
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