How can currency traders at banks make so much money when retail forex traders lose so much money?

Posted By Scott Philips On Wednesday, December 21st, 2016 With 0 Comments

Is it due to being better informed by research? Better trading technology? Or something else?

This is an interesting question.

Firstly, the overwhelming majority of retail FX traders just completely suck, and at the same time are unaware they suck. Retail FX people learn the first basic things about technical analysis (an enormously large portion of which is empirically incorrect) and think they are suddenly experts, it’s like a perfect storm for the Dunning Kruger effect. Also they are magnets for the course selling, ebook hawking, stock tippers and FX robot sellers (pro tip – none of that stuff works). Amateurs are generally completely enamoured with entry setups and predictions, which in my experience are a very small component of real trading which is primarily about risk management. When retail traders approach competence, from exposure to other retail traders they tend to think they are genuine rockstars, instead of average people almost ready for the real game.

There are extremely good retail FX traders. They measure their performance and approach trading like any other skill building exercise. They build extensively backtested systems with fundamentally sound principles behind them.

I’ve met a dozen or so institutional traders through my exposure to Van Tharp, and I collaborated with a very good G10 trader from BNP, and mostly they are not what I would call expert traders, though I have never met an incompetent one. Of course, it is unlikely I would have met a truly expert institutional trader who felt like they needed to take a Van Tharp course, since one of the things I have noticed about good traders is they have a sense of “the search is over” and aren’t interested that much in details of another trader’s method.

It goes without saying that the very best in the world at trading are working where the compensation is highest – at banks and hedge funds.

For a start institutional traders are universally intelligent, just getting thru the door of a big institution means you are superbly educated, motivated, highly intelligent with a proven work ethic. Also, if they rocked up at Goldman Sachs and said to a coworker “you know, I read this blog where they talk about how phases of the moon affect the stock market, and I think I’ll try trading on that basis” they would probably be drug tested, then fired. Ditto for “you know we are in a wave 5 of 5 of 5, and we will make a generational top in equities on …. date, before making a market top that will stand for 50 years and precipitate a 90% decline in equities”. Big banks do a decent job of training and mentoring their people, to the point where you don’t see anyone who is just incapable of doing the job or egregiously incompetent. I’m sure some of the real institutional traders here could add to that.

My experience is that institutional traders exhibit exactly the same cognitive biases as retail traders do, and their compensation schemes at times rationally encourage bad trading (if they are approaching year-end bonus and in the hole, it is rational to take risks which are objectively poor trading). I remember talking with a very smart options volatility trader for a fund, Ph.D in physics, who was emotionally shattered after having his first losing year in 5 years. He told me there was a star trader in his group and he would never take a position that was against him. Objectively that is not good trading. He was also being encouraged to take more value at risk to bring himself out of drawdown. Objectively, encouraging staff to take on more risk when they are trading badly would be suicide for the retail trader.

I trade with a few million dollars, it’s a completely different animal from trading with billions. Personally I don’t think I would do very well in that environment, and within the employment constraints of a big bank or fund.

Bottom line, the reason bank traders are consistently profitable is a mixture of selecting the right people, training, but mostly order flow. A bank trader will make a lot of his yearly P&L from trading around the order book.

Making money off order flow is something I will never be able to do as a retail trader.

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