Dominators versus Dreamers: The Tale of Two Paths in the Market

Since the beginning of FY 2021, the market capitalisation of companies listed on the BSE has surged by approximately Rs 260 lakh crore. What’s particularly encouraging is the fact that retail investors have been significant participants in this growth of wealth. In the same period, retail investors’ share in listed companies—excluding their indirect holdings through mutual funds—has increased from about 8 per cent to 10 per cent. This translates to an increase of nearly Rs 3 lakh crore in retail investor wealth.

It’s a rewarding story for those who have remained invested in equities for the long haul. But there’s another, less fortunate side to this tale, one that involves more adventurous and aggressive investors who ventured into the world of futures and options trading, which demands far greater sophistication and skill. SEBI’s recent findings reveal a sobering reality: 93 per cent of individual futures and options traders suffered losses between FY22 and FY24. In this period, 1.13 crore unique individual traders collectively incurred net losses amounting to Rs 1.81 lakh crore in this segment.

Essentially, much of the gains achieved in the cash segment were erased by losses. Futures and options trading, particularly options, is inherently complex, requiring substantial expertise to navigate profitably. But there is also another factor that is leading to such losses for individual investors. They face off against sophisticated hedge funds like Jane Street and Millennium, which employ advanced, high-frequency trading (HFT) strategies that are often too intricate for the average investor. Some of these strategies might even seem manipulative from a retail perspective.

Take, for example, the tactic known as ‘liquidity sweeping’. Here, funds buy or sell all the available liquidity at specific price levels, often hitting retail investors’ ‘stop loss’ orders and distorting the market. A hedge fund might buy all the available sell orders up to a certain price, causing the stock to spike, or dump shares to drive prices down, only to have those prices revert after they have made their move. Retail investors often get caught in these artificial fluctuations, buying at inflated prices or selling at artificially low ones, believing the moves reflect natural market dynamics.

Another edge that hedge funds leverage is ‘latency arbitrage’, where they exploit tiny time lags in the transmission of market data. Equipped with faster technology and direct access, these funds can act on new information before retail investors even see it. By the time an individual investor reacts, the hedge funds have already capitalised on the opportunity, leaving the rest playing catch-up.

So, how can retail investors protect themselves against these tactics and the resulting market volatility? A few simple strategies can go a long way. First, using limit orders instead of market orders allows you to control the buy or sell prices, reducing your exposure to rapid swings. It’s also wise to resist the temptation of chasing stocks that are moving rapidly; these moves might be driven by temporary manipulations that soon reverse.

Furthermore, adopting a diversified, long-term investment approach helps mitigate the impact of short-term volatility, a favourite playground for hedge funds. Retail investors should therefore stay focused on their long-term financial goals, avoid making emotional trading decisions, and stick to strategies that reduce their vulnerability to market manipulation. Investing is a marathon, not a sprint, and the key to success lies in maintaining discipline and keeping sight of the bigger picture.

RAJESH V PADODE
Managing Director & Editor