Institutional Trading Strategy

Institutional Trading Strategy: Rules, Backtest, and Analysis

Trading securities can be as simple as clicking the buy or sell button on your trading device, and the trade orders get executed. While that may be true for retail trading, it may not be so for institutional trading which requires a lot of tact and planning. But what exactly is an institutional trading strategy?

An institutional trading strategy is the buying and selling of financial assets, such as stocks, commodities, currencies, futures, and options by institutions like banks, credit unions, pension funds, hedge funds, mutual funds, and REITs.

The way and manner these institutions make their trades are referred to as an institutional trading strategy. Now, let’s take a look at how institutional traders play the market. As you’ll discover, they are a bit more “sophisticated” that the average retail trader, but we also explain how you as a retail trader can employ some institutional trading strategies in your own trading.

Let’s dive in:

What is institutional trading?

Institutional Trading

Institutional trading is the buying and selling of financial assets, such as stocks, commodities, currencies, futures, and options by institutions like banks, credit unions, pension funds, hedge funds, mutual funds, and REITs. These institutions are legal entities that accumulate funds from several different investors to trade on their behalf.

Trading institutions are well organized and wealthy enough to employ the services of both analysts and traders, where the former focus on making technical and fundamental analysis, while the latter study the information and use the strategies and results that they consider most convenient to execute trades.

Given their capital capacity and the fact that they trade with pooled funds, these institutions trade in huge volumes that can exert a huge influence on the price dynamics of financial instruments they trade. As such, they have to trade with complex methods and strategies to avoid disrupting asset prices, which could be to their detriment.

They often use block trade that is parsed over many brokers and traded over several days or trade via contracts, such as forwards, swaps, and so on, which might not be available to the retail traders, because they require huge funding and are mostly successful in long-term investments.

Moreover, by dealing with huge volumes and special contracts, institutional traders have access to better prices in the market and can even directly influence the price movement of the assets they trade. As a matter of fact, institutional traders fight themselves to try to control the market and drive it towards their interests. As a result, the impact of institutional trading on stock prices can be substantial.

Executing market orders are actually one of the most important things for an institution. For example, the Medallion Fund led by Jim Simons uses special algorithms to place trades to avoid slippage and not to move markets.

Who are institutional traders?

Institutional traders are the traders employed by financial institutions and trading firms to trade for them and their clients. Since they trade for big firms, they control large trading capital and 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.

The best strategies can be found in our….

Strategy Shop

Backtested trading strategies

Institutional traders are not usually charged marketing or distribution expense ratios, and they can negotiate basis point fees for each transaction and require the best price and execution. They have the ability to invest in securities that generally are not available to retail traders, such as forwards and swaps, as well as IPOs. The complex nature and types of transactions typically discourage or prohibit individual traders.

Institutional traders often trade a large volume, which can greatly impact the share price of a security. As a result, they sometimes may split trades among various brokers or over time in order to not make a material impact.

Another thing about institutional traders is that they select the kind of stocks (or markets) they trade — they often focus on higher-cap stocks, as they have more liquidity. These traders avoid smaller-cap stocks because they 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 their trades.

Institutional traders must not be mixed with proprietary traders (read here for prop trading strategies), even though they are in some ways similar.

How do you identify institutional trades?

As we already stated earlier, institutions trade in large volumes. So, the primary way to identify institutional trades is by observing the trading volume. What you should be looking for is a successive volume increase that shows true buying demand. The volume increase also doesn’t have to be huge; a one-time volume spike is not good enough.

Look for noticeable but gradual increases, like 10% or 20% increases, that are sustained over a few weeks. The last thing an institutional investor wants to do is call too much attention when they are building a position. So, they take about three weeks to gradually build their position. As a retail trader, you have to look for their fine footprints — gradual but sustained volume increase over a few weeks.

What is the difference between retail and institutional trading?

There are many differences between retail traders and institutional traders. The table below highlights some of them:

Retail tradingInstitutional trading
It involves buying and selling securities for your personal account.It involves financial institutions buying and selling securities for their managed accounts.
Trading volumes are low and cannot influence the markets.Trading volumes are large and can affect prices significantly.
Trading fees are not easily negotiated.Can negotiate trading fees and price execution.
Do not usually have access to certain securities like swap deals and IPOs.Have access to any contract they want, including swaps, forwards, and IPOs.

What are some institutional trading strategies?

Institutions can trade with any strategy they want, but these are some of the common methods they use:

  • Global macro strategy: This is a strategy used mostly by hedge funds and other trading firms. They invest across the world by considering macroeconomic factors, such as government policies, national debts, natural disasters, and so on. They can invest in all kinds of instruments, including currencies, commodities, and index ETFs. Please also read our article about macro trading strategies.
  • Index rebalancing: Mostly employed by mutual funds, it involves realigning the weights of the financial instruments in the portfolio. The rebalancing of the index is to keep the portfolio balanced by modifying the financial instruments in the portfolio in such a way that the risk remains more or less the same over a period. Rebalancing creates opportunities for small retail traders. An example is the Russell 2000 rebalancing that takes place in June every year.

Where can I find institutional trading charts?

You can see the signs of institutional trading from your usual chart if you know what to look for. But there are special publications that report institutional trading activities, such as Bloomberg, Thomson Reuters, Factset, Marketwatch, and so on.

Institutional trading strategy (backtest and example)

The majority of the institutional players make their strategies with other aims than the typical retail investor. While the retail investor is often looking for the holy grail trading strategy, the institutional investor is much more interested in having a portfolio of trading strategies that are uncorrelated to each other.

Let’s give you an example by showing the performance of a hedge fund – the Swedish hedge fund group Brummer & Partners. Let this serve as our backtest of an institutional trading strategy.

Their fund called Multi-Strategy consists of 7-11 different strategies and/or managers that trade different types of strategies (the number of funds and managers vary over time). Here’s their historical performance (even better than a backtest):

Institutional trading strategy (backtest)
The historical performance, statistics, and trading metrics indicate that Brummer & Partners is on to something.

The solid red line is the performance of the fund, and the dotted red line is the same fund with 2x leverage. The risk-adjusted return (how to measure risk-adjusted return) is good due to the low drawdowns. For example, the grey line is the MSCI world index for stocks, and stocks suffer from “gut-wrenching” drawdowns once in a while (which you avoided with the Multi-Strategy). Any wealthy investor is likely happy to diversify some of his funds into Brummer to make a portfolio that is diversified.

One of the funds (management groups) involved in Brummer’s Multi-Strategy is Lynx. They write the following on their web page:

The Lynx Program is a broadly diversified managed futures strategy that aims to deliver high risk-adjusted returns that are uncorrelated to traditional asset classes, particularly during periods of market stress.

How do they manage that? They do that by trading systematically. By that, we mean many strategies that cover different asset classes, market directions, and time frames. The group trades over 100 markets! They manage this by having a group of close to 100 scientists and math wizards that look at data-driven and quantified strategies all day long. It’s a game of probabilities and statistics (and managing risk when things go wrong).

Does it work? We would say so. Their fund is very valuable for investors because of its strong performance in bear markets (marked in bold). Here is their track record in % compared to S&P 500 (10% CAGR since its inception):

YearLynxS&P 500

The performance is exceptional during bear markets in stocks. This is much of the essence of the institutional trading strategy!

The institutional trader and investor have bigger capacities than the retail trader. Any institution has more human resources, better tools, and MUCH more capital. The latter might be an impediment, though, as a big capital base makes it more difficult to trade and move size.

List of trading strategies

Since we started this blog in 2012 we have written many trading strategies that you can read for free, please see our complete list of trading systems. The strategies can help you copy some of the ideas and logic that institutional traders use.

We have compiled the Amibroker code and logic in plain English for all these strategies (plain English is for backtesting in Python). If you subscribe, you’ll get the code for the latter strategy (plus over 150 other ideas).

For a list of the strategies we have made please click on the green banner:

These strategies must not be misunderstood for the premium strategies that we charge a fee for:

Institutional trading strategy – conclusion

We believe the goal of any aspiring retail trader should be to trade like a big institution: trade many strategies across different asset groups, trade different time frames, and above all, trade both market directions (long and short). The institutional trading strategy is not as difficult to employ as you imagine, but it requires some time on your end and some capital.

Can the strategy be improved?

We are not oracles, and we are pretty sure there are traders out there who can improve the strategy. Do you have any ideas on how to improve it?If so, please comment below or drop us an e-mail.


How do Institutional Traders Differ from Retail Traders?

Institutional traders, employed by financial institutions, trade on behalf of managed accounts with large capital, influencing market prices significantly. In contrast, retail traders trade for personal accounts with lower volumes that have minimal impact on market dynamics.

What Strategies do Institutional Traders Use?

Institutional traders employ various strategies, including global macro strategies that consider macroeconomic factors, and index rebalancing, commonly used by mutual funds. The diversity of strategies aims to create uncorrelated portfolios for risk management.

How do Institutional Traders Manage Risk?

Institutional traders manage risk through a combination of systematic trading, diversification, and employing risk-adjusted return metrics. They often have dedicated teams of analysts and traders to continuously assess and adapt their risk management strategies.

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