Institutional Trading Strategy — What Is It?

Last Updated on August 25, 2022 by Oddmund Groette

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?

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. The way and manner these institutions make their trades is referred to as institutional trading strategy.

Now, let’s take a look at how institutional traders play the market.

What is 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.

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.

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 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.

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 trading Institutional 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
  • 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.

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)

A backtest of an institutional trading strategy is coming soon.

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