The thing about edge

[tradingjournals]

Quote from kut2k2:

Eckhardt

So you read fairy tale books, which others call trading books.

 

[dbphoenix]

Quote from tradingjournals:

One day he may realize that more than 80% have to lose for 20% to win. If everyone could win who is going to pay? people who win start with the correct assumptions. And the first is that trading is zero sum game (without commission and spread). One person (people say she is a woman) indicated that one has to think of trading as a river. There is enough for all, and added that she gets paid for her time in the market. The people who lose also spend time, and they drown in the river because someone has to down for someone to win and for the broker and market maker to earn. This is not about time spend and hard working and all the empty assumptions: It is about risk in a zero sum game.

Since NoDoji has been misinterpreted, it will be of value to quote her reply here:

Quote from NoDoji:

You're asking who gets left out as if the markets were a single game of musical chairs.

Try thinking of the markets as rivers of opportunities instead. There are many ways to derive profit from a river:

You can fish in the river and channel some water to irrigate a garden and feed yourself throughout the year.

You can fish in the river or irrigate a farm and sell your fish/food to others for a profit.

You can take people on river rapids day trips or camping trips.

You can conduct research at a river on behalf of a university or a foundation.

You can dam a river and generate power.

All these things are possible, yet at the same time you can get drunk while fishing, fall into the river and drown.

You can get greedy and implement a fishing method that removes so many fish from the river so quickly the population goes extinct.

You can farm too close to a river that's known to flood frequently and have your crops ruined.

Rivers of opportunity for those who prepare well and hedge their risk.

Trading, in other words, is a "zero sum game" only for those who aren't prepared. It is not by definition a zero sum game.

 

[llIHeroic]

Quote from tradingjournals:

typical misinterpretation after having glossed over some content without really thinking about what it says

1. Company A will produce 1000 units of X in the next two months.

2. Company A shorts a futures contract to manage the risk of price fluctuation.

3. I buy the contract, because I am willing to take their risk in exchange for a potential gain.

4. In two months, the market is ready and willing to pay $2 more per unit than at the time of our transaction.

---

Explain to me how this is a zero-sum game. Who exactly is the loser here?

 

[xelite777]

Quote from llIHeroic:

1. Company A will produce 1000 units of X in the next two months.

2. Company A shorts a futures contract to manage the risk of price fluctuation.

3. I buy the contract, because I am willing to take their risk in exchange for a potential gain.

4. In two months, the market is ready and willing to pay $2 more per unit than at the time of our transaction.

---

Explain to me how this is a zero-sum game. Who exactly is the loser here?

If the CEO of company A shorts a futures contract, let's say wheat, he is in fact betting that the price of wheat will drop soon. If I buy the contract and the price of wheat increases, I make money. Where is that money coming from? From the CEO's pocket.

If the price of wheat decreases the CEO wins and this time MY money goes into his pocket.

Zero-sum game.

 

[dbphoenix]

Quote from xelite777:

If the CEO of company A shorts a futures contract, let's say wheat, he is in fact betting that the price of wheat will drop soon. If I buy the contract and the price of wheat increases, I make money. Where is that money coming from? From the CEO's pocket.

If the price of wheat decreases the CEO wins and this time MY money goes into his pocket.

Zero-sum game.

Or the price does in fact fall, after which the CEO covers his short at a profit by selling it to you. You buy it expecting that price will rise, which it does.

You both make money.

 

[drownpruf]

The OI results in a zero PNL. Commissions are another matter. The sum of all contracts traded results in no wealth creation or destruction. Like conservation of energy as an analogy.

They're derivatives and zero-sum as no futures contract is "inherited."

 

[drownpruf]

Quote from dbphoenix:

Or the price does in fact fall, after which the CEO covers his short at a profit by selling it to you. You buy it expecting that price will rise, which it does.

You both make money.

Two distinct and unrelated transactions. You're ignoring the initial buyer.

 

[Gringo]

Quote from llIHeroic:

1. Company A will produce 1000 units of X in the next two months.

2. Company A shorts a futures contract to manage the risk of price fluctuation.

3. I buy the contract, because I am willing to take their risk in exchange for a potential gain.

4. In two months, the market is ready and willing to pay $2 more per unit than at the time of our transaction.

---

Explain to me how this is a zero-sum game. Who exactly is the loser here?

Company: Short futures + producing unit of X (which means more or less long X)
You: Long contracts of X

Price: Ends up $2 up.

Result: Company loses on futures + gains on price of each units of X

Net result: The gains coming from the rise in price of X are not materialized for the company because the futures contract 'reduced' the profit by the amount of the futures contract.

This reduction in gain or profit is shifted to 'You' who was long the futures and taken from the company.

Assuming a perfect hedge and no broker costs, the potential gains because of hedging were shifted to 'You'. from the company. In the absence of that hedge the company would have gained $2 value per unit of X which it didn't in this case. In other words the company locked in it's price of unit X when it sold futures short. The later gain in price is all shifted to the futures buyer. Hence a 'zero-sum' game.

Although this example may not have been most lucid, I do believe what Db is trying to point out is something different. I am not certain what it is but perhaps he'll illuminate us later.

Gringo

Edit: It is quite possible for both to make money, but the idea isn't that two parties are playing a zero-sum game. The idea is that 'someone' loses and those loses are shifted to the winner. In the above response case as Db pointed out recently, where CEO buys back the contract after drop and makes money, the price of unit X is still dropping, lowering again the earlier profits on unit X. Now if a third party gets involved the loses could be shifted to that party and the first two participants may end up making money. But I am too rusty with this futures business and could make an error in judgement, so tread with caution.

When CEO shorted, he sold to 'someone' who's losing money. When 'You' buys it at the bottom, and price goes up. CEO made money, and 'You' made money, but the sucker CEO sold short to 'lost' money.

 

[kut2k2]

Quote from dbphoenix:

When did consistent profits become incompatible with positive expectation?

I didn't say they were. Consistent profits are a necessary component of an edge.

But you said you disagree with point one. Positive expectation is necessary for consistent profits. What's the disagreement?

Quote from dbphoenix:

And do it manually? Wm Eckhardt doesn't trust any strategy tested on fewer than 1800 trades. Try doing that manually, just for the testing phase of each candidate strategy. I'm not as rigid as Eckhardt but I do like to see several hundred trades before I trust test results.

That's your choice, and Eckhardt's, but it's not a given.

So how many trades do you use to determine winrate and consistent profitability?

Quote from dbphoenix:

As to the alleged unreliability of backtesting, that's due to lazy traders taking shortcuts like assuming there are no commissions. Backtests can be made as realistic as any forward sim if a trader cares to take the time and effort to do it.

Depends on how it's conducted. If the trader is looking only at the results with which the computer provides him rather than the charts themselves, then the actual trading is going to be quite a surprise.

People were performing successful tape reading long before charts came along. The notion that only charts can provide good trading signals is a strange one.

Quote from dbphoenix:

Incidentally, what is or is not off-topic is entirely up to you. If I venture off into areas which are of little or no interest, just say so and I'll stop.

Not a problem.

 

[vcir]

Quote from drownpruf:

Two distinct and unrelated transactions. You're ignoring the initial buyer.

Enough said!