Forex Trading: Retail vs. Institutional
Retail forex trading lets individuals take on the market, while institutional trading sees financial powerhouses move the market.
Did you know that forex trading for retail traders primarily involves speculating on currency pairs rather than the direct buying or selling of physical currencies?
Forex trading, whilst often perceived as a uniform practice, fundamentally differs between retail and institutional traders.
Retail Traders
Retail traders typically use Contracts for Difference (CFDs) to speculate on currency pairs.
CFDs are financial derivatives that allow traders to profit from price movements without owning the actual currencies. This method involves cash-settled trades based on price changes rather than direct currency exchanges. More importantly, CFD trades do not impact the broader forex market or affect currency supply and demand.
When retail traders place orders, these are processed through brokers.
Market makers, also known as dealing desk brokers, typically execute trades by matching buy and sell orders within their own books rather than routing them to the wider forex market.
No Dealing Desk (NDD) brokers, including those using Straight Through Processing (STP) or Electronic Communication Networks (ECNs), may route orders to liquidity providers. However, even in these scenarios, retail trades do not affect the interbank market.
Institutional Traders
Institutional traders, including banks, central banks, multinational firms, and hedge funds, operate on a different scale to retail traders. Rather than speculating on price movements through leveraged accounts, these large corporations deal in physical currency transactions, buying and selling in huge quantities. Their presence in the forex market isn’t just influential, it’s fundamental.
Beyond spot transactions, institutions use forward contracts, currency swaps, options, and futures to manage future obligations and protect against currency risk. These instruments offer flexibility to hedge volatility or take strategic positions on anticipated price movements.
The institutional forex market dwarfs the retail sector, with daily trading volumes reaching trillions. These transactions help shape exchange rates and drive market movements, often responding more rapidly to economic data and geopolitical risks.
Unlike retail traders, whose focus is largely speculative, institutional players are deeply tied to real-world economic activity, whether it’s financing international trade, managing cross-border investments, or stabilising national currencies.
Bottom Line
Institutions dominate the forex market as the primary drivers of currency exchange, while retail traders primarily speculate on institutional actions.
Rather than directly exchanging currencies, retail traders leverage financial instruments to profit from price movements caused by these larger market participants.
Frequently Asked Questions
Still have questions about retail and institutional traders? Here are some quick answers to the most common ones.
Why don’t retail forex trades impact currency prices?
Retail traders mainly use CFDs, which are speculative instruments that don’t involve actual currency exchange. Since these trades are often processed internally by brokers rather than through the interbank market, they don’t contribute to overall currency supply and demand.
How do institutional forex transactions influence exchange rates?
Institutions engage in large-scale currency transactions for trade, investment, and hedging. Their high-volume activity directly affects supply and demand, influencing exchange rates in response to economic data, monetary policy, and geopolitical events.
Are there any retail traders who trade physical currency instead of CFDs?
While most retail traders use CFDs, some may engage in forex trading through spot accounts that provide access to actual currency exchange. However, these traders still operate at a much smaller scale compared to institutions and typically do not impact currency prices.
Can retail traders access the same liquidity pools as institutional traders?
Generally, no. Retail traders operate in a separate ecosystem managed by brokers, whereas institutions trade directly with banks and other large entities. Some ECN and STP brokers offer access to better liquidity, but retail traders still don’t participate at the institutional level.