Asset Management

12:28 PM
Dan Cook
Dan Cook
Commentary
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The Rise of the Retail Trader – a New Era

Retail traders are coming back, but their sights are set on more transparent and low risk instruments, which is adding momentum and service demands to previously quiet markets.

As we all know, the 2008 crash has drastically shifted the entire perception of the markets, significantly impacting both retail and institutional traders. Prior to this downturn, traders and investors alike believed the markets were stable and there was an opportunity for sustainable wealth accumulation. Then came the market chaos of 2008. With concerns about the stability of the free market world and the phrase “too big to fail” in the headlines every day, people were quite simply afraid to trade.

The new mantra was no longer growth, but preservation of funds, which led the broader population to move into cash positions or other instruments deemed less risky. It became a totally risk-averse environment as traders aimed to stabilize their finances as quickly as possible. Adding to this catastrophic event, the flash crash came at a terrible time, as well as the infamous examples of fraud and corruption exploding in the news, such as Madoff, MF Global, and Peregrine Financial. Investors and traders were already skittish, but following these historic scams it became a much deeper issue than just market structure, as former participants lost trust in the firms they were dealing with and the regulators that were charged with overseeing them.

A slow return to the market
Trust is slowly returning to the market as regulatory oversight and transparency has improved, however regaining traders’ confidence in the market can be difficult. As time has passed though, we have witnessed a slow, but steady migration back to the markets. Undoubtedly, one of the biggest drivers encouraging market participation stems from the Fed’s quantitative easing measures, as it has pumped in enough capital to send the markets on a bull run more exciting than anything ever witnessed in Pamplona! With a low- to no-interest rate environment, traders have sat back and watched the market recover and are now more eager to jump back in. In addition to overall market conditions improving, the industry has evolved as well. With new trading venues and the creation of exchanges designed specifically for the retail trader, individuals can get involved at a financial level comfortable for them where they can fully control and minimize their risk.

While retail traders are coming back in numbers and trust is improving, all that was broken has not been fixed. When examining a retail traders’ portfolio today, these traders are willing to risk much less than they were prior to 2008. This makes it difficult for retail traders to participate in markets designed for institutional traders and, if they do, their trade sizes are usually much smaller than they would have been previously. There are alternative venues available and they are starting to gain traction, but providing proper education around these trading opportunities will be a key component to growth.

Another important factor impacting retail traders returning to the market is transparency, as it is paramount to this segment. Remember, no one wants to dive head-first into a murky lake! Transparency promulgates trust as everything can be seen from the outset of the trade through to the close or settlement.

Traders take control
More retail traders (and the broader population as a whole) are taking control of their finances -- at a minimum with a portion of their overall funds. In 2008-2009, the world watched as the savvy “professionals” lost 70% to 75% of their money and market participants quickly realized what a mistake it was to give someone else total control over their financial futures. As a result of these events, individuals – even if they do not manage 100% – want to control at least a portion of their portfolio. It is important that these traders are educated on how the market moves in order to become more comfortable with the trading activity they are engaging in. There really is no better education, or anything as challenging and potentially rewarding, than placing that first trade when you are the one who is accountable for all aspects.

Retail traders leveraging binary options
Within the past 18 months, there has been an increase in binary options trading volumes in the US. In fact, on Nadex, the average daily volume has nearly tripled in this time frame. For the retail market, there are several key aspects which make these instruments so appealing to this segment of traders, including the low barrier to entry which means an individual can start out at a level comfortable to them -- whether that is a few hundred dollars or thousands of dollars. Through the small contract sizes, retail traders maintain tighter control of their exposure, and the limited risk of these contracts allows traders to know up front the maximum they can lose on a trade.

In the US, binary options are traded only on regulated exchanges, which meets the transparency need retail traders are seeking in order to feel confident about their trading activity. Additionally, traders can engage in a market they are familiar with, given the wide array of asset classes underlying Nadex contracts. The most significant benefit is that novice traders can learn in an environment that is intended for them, since the contracts are designed for this segment on a fair playing field and are not overpowered by institutional investors. For experienced traders the same reason applies, with the additional benefit of these being complementary contracts that can be used in conjunction with other markets as a risk mitigation tool.

The future for retail traders
In my opinion, we have only scraped the very tip of the iceberg in growth for this sector. As binary options volumes grow, so does the interest from major brokerage firms needing to offer these popular contracts to their clients. The additional volume also creates space and flow for other liquidity providers to service these markets. The retail trader will continue to increase participation in the market. As momentum builds, the proper education and trading vehicles will elevate this sector exponentially.

As Director of Business Development for the North American Derivatives Exchange (Nadex), Dan Cook is responsible for introducing Nadex to the broader trading community and providing education opportunities for traders to learn about the unique, limited risk contracts offered ... View Full Bio
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Greg MacSweeney
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Greg MacSweeney,
User Rank: Author
6/30/2014 | 6:41:21 AM
Re: good to see
I'm not sure if retail traders will ever account for two-thirds of the market again. Even if there is an explosion in demand from retail investors, I would think that computerized trading and HFT would still account for more of the volume. After all, a good portion of HFT just plays off of retail investors. So, if there is an increase in retail trading, HFT will increase as well.
Becca L
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Becca L,
User Rank: Author
6/29/2014 | 9:21:42 PM
Re: good to see
When we talk about someone who sees binary options as fitting to their portfolio, we're referring to a savvy and literate retail investor. This is important to differentiate from the whole of the broader trader population returning to the market, which consists of many casual investors. I'd argue many individual investors are drawn to the post-08 market by brokerages that hand-hold with nice layouts for that are easily digestible for novice users, gamification, and yes, increased confidence. In time they may start to feel more comfortable placing their money in more complicated and unfamiliar sounding instruments like "binary options" but there's a gap there that still needs to be addressed. This growth of this market is very interesting, but I'm curious if it's only within a niche subset of investors..
Becca L
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Becca L,
User Rank: Author
6/29/2014 | 9:20:56 PM
Re: good to see
Ivy, do you think it likely we'll ever see retail traders represent more than 50% of the market again?
IvySchmerken
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IvySchmerken,
User Rank: Author
6/29/2014 | 11:15:56 AM
Re: good to see
Retail traders are taking advantage of improved platforms and seem to be drawn to new instruments, and it seems like binary options is gaining their attention. Retail traders probably prefer to control their own destiny after many suffered loses during the financial crisis relying on financial advisers.

However. the return of the retail trader is different from the retail investor. Retail investors comprise about 50% of the stock market, which is down from arond two thirds in 2000.
IvySchmerken
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IvySchmerken,
User Rank: Author
6/29/2014 | 11:15:46 AM
Re: good to see
Retail traders are taking advantage of improved platforms and seem to be drawn to new instruments, and it seems like binary options is gaining their attention. Retail traders probably prefer to control their own destiny after many suffered loses during the financial crisis relying on financial advisers.

However. the return of the retail trader is different from the retail investor. Retail investors comprise about 50% of the stock market, which is down from arond two thirds in 2000.
Greg MacSweeney
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Greg MacSweeney,
User Rank: Author
6/25/2014 | 11:05:55 AM
good to see
It is nice to see that retail traders are coming back to the markets. So many were burned so badly over the past decade that many are still afraid to return. But new markets, instruments and tools will certainly help.
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