Summary In financial markets, the performance of retail investors and institutional investors often presents a stark contrast. While retail investors still cannot match the vast capital of institutions, the difference between them stems more from differences in methodology, trading methods, and risk management than from differences in transaction costs or information. Government and central bank interventions, or commitments to intervene, are common sources of implicit subsidies. Originally published on November 6, 2025 For most investors, the question "What is trading?" is one they've never seriously considered. Many see trading as a means to "get rich overnight," while others equate it with "gambling." In reality, the "trading" understood by retail investors and the "trading" understood by institutional investors are completely different things, and this is the key reason for the difference in investment results. In financial markets, the performance of retail investors and institutional investors often presents a stark contrast. According to multiple studies, over 70% of retail investors fail to outperform the market in short-term trading and even incur losses of principal. In contrast, institutional investors, such as hedge funds, pension funds, and banks, typically achieve relatively stable and consistent returns. This gap is not accidental but stems from multiple factors, including behavioural psychology, information resources, strategy execution, and market structure. Decades ago, the gap between individual and institutional investors was almost "insurmountable." Institutional investors possessed sufficient information asymmetry, gaining access to information days earlier than retail investors. They could also borrow large sums of money or seek powerful partners to influence or even manipulate the market. In contrast, retail investors cannot use derivatives and must place orders through brokers when buying and selling stocks, incurring significant transaction costs; as a result, day trading is virtually impossible. However, in the 2020s, thanks to the development of the internet and blockchain technology, everything changed. Retail investors can easily access tools like options, using leverage to beat short-selling institutions. Retired legendary traders share their trading strategies in communities, leading investors to previously unattainable returns. Algorithmic trading is no longer the exclusive domain of hedge funds and market makers, and real-time data and charts are readily available on any device. Clearly, the difference between institutions and retail investors has narrowed significantly, and in some areas (such as arbitrage trading), it is now merely a difference in scale. Therefore, while retail investors still cannot match the vast capital of institutions, the difference between them stems more from differences in methodology, trading methods, and risk management than from differences in transaction costs or information. However, it is precisely these different methodologies, trading methods, and risk management approaches that lead to different investment results for retail and institutional investors in most situations. In this series of articles, we will take an institutional perspective to "reshape" the investment mindset of retail investors, combining institutional trading thinking and methodologies with daily investment to help investors build the right trading logic and a robust investment framework. What Is Trading? Trading refers to the process of buying and selling various assets in financial markets, with the intention of profiting from price fluctuations or hedging risks. These assets include stocks, bonds, foreign exchange, commodities, cryptocurrencies, and derivatives (such as futures and options). The above definition comes from university classrooms and textbooks. In practice, institutional trading primarily aims to "obtain stable excess returns," that is, to achieve returns exceeding those of risk-free assets, such as government bonds and cash, while keeping risks under control. The reason is simple: one of the primary sources of income for financial institutions, such as banks, is the interest rate spread. Without excess returns, after inflation correction, the interest rate spread may not be able to withstand inflation's erosive effects. For retail investors, this is also one of the main purposes of trading: to hedge against asset devaluation caused by inflation. On the other hand, "hedging risk" itself may also be a purpose of trading . Many companies participate in futures and options trading to hedge against risks associated with inventory price fluctuations and ensure stable cash flow. With the gradual democratisation of derivatives, retail investors can also use derivatives to hedge some of the higher-risk exposures in their portfolios, such as cryptocurrencies and small-cap stocks. It is not difficult to see that the core of trading is not speculation, but rather the management and effective allocation of risk. In this process, investors choose to bear certain risks and opportunity costs in exchange for potential portfolio performance optimisation and additional returns. Of course, speculative elements also exist in trading, but they typically occur after additional returns have already been achieved. When there's a surplus, many people will use the money meant for chewing gum or chocolate to buy a lottery ticket. Similarly, for institutions, using a portion of surplus funds for speculative trading is nothing new - it can even be seen as a potential means of enhancing returns: even if these funds are completely lost, it won't significantly impact this year's revenue, while a successful bet can "add icing on the cake" to portfolio performance. However, it must be acknowledged that in most cases, the stable returns of institutions do not come from those bets. So, where do the excess returns of institutions come from? Source of Trading Profits: Implicit Subsidies Implicit subsidies are one of the magic wands institutions use to generate trading profits. In financial markets, implicit subsidies are a unique phenomenon referring to premiums paid for trades that are not for traditional risk-return optimisation purposes. Unlike regular risk premiums, implicit subsidies arise from market inefficiencies, offering investors stable trading opportunities and returns. To some extent, implicit subsidies can be viewed as a service fee. In the derivatives industry, implicit subsidies are referred to as "convenience yields," which represent the costs incurred in holding derivative contracts. A typical example is BTC ETF issuers: after acquiring BTC spot, they open short positions in BTC futures on the CME, obtaining convenience yields while hedging against price volatility risk. Convenience yields depend on the supply and demand of the contract, not the price, and are consistently positive over the long term, providing institutions with continuous and stable returns. In fact, implicit subsidies are widespread in financial markets. Government and central bank interventions, or commitments to intervene, are common sources of implicit subsidies. Issuers of emerging market bonds typically pay a premium to investors to compensate for potential liquidity risks and higher default risks compared to more developed markets. During periods of significant price volatility, risk-averse investors are often willing to pay a higher premium to buy options or other derivatives to protect their positions, or pay substantial slippage to liquidate their holdings. Based on these market participants' needs, institutional investors can obtain implicit subsidies from multiple sources: banks can receive subsidies from central banks by providing liquidity in the repo market, fixed-income traders can obtain subsidies from the bond market through curve trading, and hedge funds and market makers can obtain subsidies by selling volatility and getting slippages—this is the secret to their long-term profitability. It's important to note that these sources of profit are not significantly related to the performance of the asset price itself. This is also a point that retail traders need to learn: directional trading does not guarantee long-term, stable returns. Clearly, institutional trading profits are not limited to implicit subsidies; this will be discussed in subsequent chapters. Stay tuned… Disclaimer: The information provided herein does not constitute investment advice, financial advice, trading advice, or any other sort of advice, and should not be treated as such. All content set out below is for informational purposes only. Original Post Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.
