I have always wondered where my earnings come from. Most traders, especially those whom I'm friendly with consistently make money over the long term. The market is essentially a zero sum game (not including the effects of commissions which continually take money out). I realize that newbies constantly loose, but a few k here or there shouldn't account for the millions that all traders make daily, (not even including NITE and it's kin). So who's money are we taking. Is it the mutual fund's money? Is it margined money or something else? I realize that money is constantly pumped into the market by retirement funds etc. Are we just taking that money? Does anyone have any input, or even understand what I'm asking?
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Where do my winnings come from?
- Thread starter praetorian2
- Start date
Hopefully http://www.hardrightedge.com/wizard/ss1.htm will answer part of your question.
Basically, you're taking money from the stupid and the large. Large sums of money are rare, but stupidity is infinite.
Basically, you're taking money from the stupid and the large. Large sums of money are rare, but stupidity is infinite.
praetorian - technically the market is not entirely a zero sum game in the normal sense and certainly not on the microscopic timescape. If a stock traded sideways within a trading range forever, then you'd pretty much have a zero sum game. But that doesn't usually happen because unlike a chess game, the gaming environment/system is not static. It is dynamic and affected by external factors (e.g., new funds entering the system).
While clearly there are two sides to each trade, it's not true that in each trade there is a winner and a loser. It's also possible for there to be two winners or two losers. Sure one party might miss out on some gains by exiting when someone else enters (or vice versa), they've only lost opportunity and not necessarily lost anything tangible as a result of making the trade.
Consider the following set of trades:
Trader A buys XYZ @ 10
A month later, Trader A sells XYZ @ 20 and Trader B buys it @ 20
A week later, Trader B sells it @ 30 and Trader C buys it @ 30
Two months later, the stock is trading at 40
In this series of trades, all three traders are winners. Of course Trader A missed out on the $20 increase that Trader B (who got $10 of it) and Trader C (who is sitting on another $10) made.
This can occur either when new funds are pushed into the market and some of it goes into that stock or when funds are shifted from other stocks to that stock - both causing the stock to rise in value as a result of buying pressure.
Now if Trader C dumps his shares just ahead of a stock price collapse, someone else certainly takes the hit. But look at a chart of say MSFT. Sure it's trading at less than half of what it was in January 2000, but it's trading (on a split adjusted basis) at about six times what it was in 1995.
So even if you integrate over all the trades done in the last 6 years you still don't arrive at a zero sum simply because the stock is still trading at 6 times what it was 6 years ago. The only way to arrive at a real zero sum conclusion for a stock is for the company to go bankrupt and the stock to become worthless or for everyone to decide that no one wants to buy it anymore and cause the stock price to fall off the face of the earth.
Even internet stocks like CMGI still haven't completely achieved zero sum game status because in spite of all of the ludicrous gyrations, they're still selling for 4-5 times what they were 6 years ago (on a split adjusted basis of course). Lot's of people took baths by holding stocks like these too long but even the huge declines still hasn't completely leveled out the game in those stocks to a real zero sum.
So now that I've made a short story long - I guess the real answer to your question is that over the long term there are always losers and winners (but not necessarily at the zero sum equivalence level) and your profits are coming partly at the expense of others in the short timeframe (either actual losses on their part or lost opportunity) and partly as a result of buying pressure created by funds continuing to be pushed into the market and thereby creating a kind of borrowing against future value situation.
Provided that more net funds continue to enter the system and/or there is positive net earnings growth over the long term (assuming that stock prices over the long term have some relationship to actual earnings - short term irrationality notwithstanding) the overall system will never be a completely zero sum game.
While clearly there are two sides to each trade, it's not true that in each trade there is a winner and a loser. It's also possible for there to be two winners or two losers. Sure one party might miss out on some gains by exiting when someone else enters (or vice versa), they've only lost opportunity and not necessarily lost anything tangible as a result of making the trade.
Consider the following set of trades:
Trader A buys XYZ @ 10
A month later, Trader A sells XYZ @ 20 and Trader B buys it @ 20
A week later, Trader B sells it @ 30 and Trader C buys it @ 30
Two months later, the stock is trading at 40
In this series of trades, all three traders are winners. Of course Trader A missed out on the $20 increase that Trader B (who got $10 of it) and Trader C (who is sitting on another $10) made.
This can occur either when new funds are pushed into the market and some of it goes into that stock or when funds are shifted from other stocks to that stock - both causing the stock to rise in value as a result of buying pressure.
Now if Trader C dumps his shares just ahead of a stock price collapse, someone else certainly takes the hit. But look at a chart of say MSFT. Sure it's trading at less than half of what it was in January 2000, but it's trading (on a split adjusted basis) at about six times what it was in 1995.
So even if you integrate over all the trades done in the last 6 years you still don't arrive at a zero sum simply because the stock is still trading at 6 times what it was 6 years ago. The only way to arrive at a real zero sum conclusion for a stock is for the company to go bankrupt and the stock to become worthless or for everyone to decide that no one wants to buy it anymore and cause the stock price to fall off the face of the earth.
Even internet stocks like CMGI still haven't completely achieved zero sum game status because in spite of all of the ludicrous gyrations, they're still selling for 4-5 times what they were 6 years ago (on a split adjusted basis of course). Lot's of people took baths by holding stocks like these too long but even the huge declines still hasn't completely leveled out the game in those stocks to a real zero sum.
So now that I've made a short story long - I guess the real answer to your question is that over the long term there are always losers and winners (but not necessarily at the zero sum equivalence level) and your profits are coming partly at the expense of others in the short timeframe (either actual losses on their part or lost opportunity) and partly as a result of buying pressure created by funds continuing to be pushed into the market and thereby creating a kind of borrowing against future value situation.
Provided that more net funds continue to enter the system and/or there is positive net earnings growth over the long term (assuming that stock prices over the long term have some relationship to actual earnings - short term irrationality notwithstanding) the overall system will never be a completely zero sum game.
Futures are not zero-sum game either. Read the chapter "the Fantastic System of Side Bets" of "Against the Gods" by Peter Bernstein. This is portion of it: "On occasion, the other side of the deal is a speculator-someone who is willing to take over uncertainty from others out of a conviction about how matters will turn out.In theory at least,speculators in commodities will make money over the long run because THERE ARE SO MANY PEOPLE WHOSE FINANCIAL SURVIVAL IS VULNERABLE TO THE RISKS OF VOLATILITY.As a result, VOLATILITY TENDS TO BE UNDERPRICED,especially in the commodity markets,and producers' aversion gives the speculator a built-in advantage. This phenomenon goes under the strange name of "backwardation".
The same point, basically, ArchAngel makes. If either game was zero-sum what would be the point of the whole think? So people would have something to do? Do not believe what the dumb reporters in major media tell you.
The same point, basically, ArchAngel makes. If either game was zero-sum what would be the point of the whole think? So people would have something to do? Do not believe what the dumb reporters in major media tell you.
I'm no economist, and have never studied economics, I'm just a simple trader. : ) So I'll give what I think in a sort of a question.
Doesnt all wealth, in trading or otherwise, eventualy trace itself back to the earth? Lumber, ore, sources of power, etc?
You didnt really take money from anyone, you took it from someone, who took it from someone, etc, untill it eventually had its roots as a natural product produced by the earth?
Same way with the company who grew, eventually the fuel for the growth came from nature. (You may have to do alot of tracing back, but eventually it can be done?)
Sorry if its a stupid question...
Doesnt all wealth, in trading or otherwise, eventualy trace itself back to the earth? Lumber, ore, sources of power, etc?
You didnt really take money from anyone, you took it from someone, who took it from someone, etc, untill it eventually had its roots as a natural product produced by the earth?
Same way with the company who grew, eventually the fuel for the growth came from nature. (You may have to do alot of tracing back, but eventually it can be done?)
Sorry if its a stupid question...
This has been a very interesting discussion, so I have to throw my hat into the ring too.
As ArchAngel so eloquently described, long-run games are not zero-sum if new entrants can participate and the life of the game is theoretically infinite. Carl J is right that futures are zero-sum (Actually, its technically negative-sum because of slippage and commissions) because they are short-run games with a finite life. Futures contracts were originally created for the express purpose of laying off risk. From the day they are created to the day they expire, each dollar made by one party is lost by the counter party. Futures are marked to market each day, so at the end of every trading day you have either won or lost and the account balance is adjusted accordingly.
Now, what Cesko said is true as well, in that over the long-run (many short-run games added together) there may be the possibility of an "edge" to a trader who has developed a good method for exploiting volatility or some other technique. This does not change the fact that every dollar put into a futures contract is removed by expiration. Having an edge may make you net positive over the long-run, but there will be an equally net-negative position, whether it is born by a single trader or many other parties involved in the contract's trading life. The gains you made had to come from someone. Writing a futures contract does not in itself create any value. By definition, a positive sum game must end with more value than it began, in other words, the winner wins more than the loser loses. This does not happen in a futures contract.
Apologies to praetorian for getting away from the original question, but ArchAngel did a great job of answering it.
Kirk
As ArchAngel so eloquently described, long-run games are not zero-sum if new entrants can participate and the life of the game is theoretically infinite. Carl J is right that futures are zero-sum (Actually, its technically negative-sum because of slippage and commissions) because they are short-run games with a finite life. Futures contracts were originally created for the express purpose of laying off risk. From the day they are created to the day they expire, each dollar made by one party is lost by the counter party. Futures are marked to market each day, so at the end of every trading day you have either won or lost and the account balance is adjusted accordingly.
Now, what Cesko said is true as well, in that over the long-run (many short-run games added together) there may be the possibility of an "edge" to a trader who has developed a good method for exploiting volatility or some other technique. This does not change the fact that every dollar put into a futures contract is removed by expiration. Having an edge may make you net positive over the long-run, but there will be an equally net-negative position, whether it is born by a single trader or many other parties involved in the contract's trading life. The gains you made had to come from someone. Writing a futures contract does not in itself create any value. By definition, a positive sum game must end with more value than it began, in other words, the winner wins more than the loser loses. This does not happen in a futures contract.
Apologies to praetorian for getting away from the original question, but ArchAngel did a great job of answering it.
Kirk
WOW!! these are some amazing responses, I guess this got into philosophy some, but I've just always wondered this. I appreciate all the responses guys.
WarEagle
The problem is that not every party which participates in the futures market seeks profit.If you are profitable futures trader you get paid for accepting and dealing with the risk and for contributing to the liquidity of the particular market, the other side might lose money but it doesn't matter because they are in for the protection from the risk.
This is, to me, win-win situation. If you think in strictly monetary sense,you are right,it's a zero-sum game. I mean, if every person's motivation is dollars then the whole life is zero-sum game.
You say:" From the day they are created to the day they expire, each dollar made by one party is lost by the counter party." You can hold the futures contract as long as you wish,you just roll over your position to the next available month.
The problem is that not every party which participates in the futures market seeks profit.If you are profitable futures trader you get paid for accepting and dealing with the risk and for contributing to the liquidity of the particular market, the other side might lose money but it doesn't matter because they are in for the protection from the risk.
This is, to me, win-win situation. If you think in strictly monetary sense,you are right,it's a zero-sum game. I mean, if every person's motivation is dollars then the whole life is zero-sum game.
You say:" From the day they are created to the day they expire, each dollar made by one party is lost by the counter party." You can hold the futures contract as long as you wish,you just roll over your position to the next available month.
Cesko,
I agree with you that the original writer of the contract does not really care whether or not it changes in value, only that the risk is no longer theirs. Even if they sell the contract and it goes straight up in value until expiration so that the trader makes a profit, the hedger still loses that opportunity in an equal amount. I didn't say that they are neccessarily concerned about it. To them, it is the cost of not having to worry about price moving in the opposite direction. There is still a transfer of "wealth" from one party to another that is equally balanced and thus zero-sum (again, ignoring transaction costs). With the exception of the hedger, yes, I am strictly looking at this from a financial standpoint, and not measuring "utility" in every possible form. While the farmer may gain comfort from laying off his risk, there is still a financial loss if he could have sold his corn at a higher price on expiration day in the cash market. All of the speculators that hold the contract before expiration are strictly in it for the money. If not, they have some psychological issues to work through and probably shouldn't be trading.
With regards to expiration, the rollover is done by selling the current month and buying a foward month (if you are long), so someone is still ending up with the contract on the last day and thus the game is finished. Whether its a physical commodity that is delivered or a cash settled contract like the S&P. Either way, the original transaction is settled up that day. It is a contract that the long and short party, whoever they may end up being, are obligated to fulfill.
So I don't disagree with you, but the point of whether life is just a zero sum game is much deeper than I have ever tried to go, I'll leave that to someone with too much spare time on their hands, lol.
Thanks for the interesting discussion.
Kirk
I agree with you that the original writer of the contract does not really care whether or not it changes in value, only that the risk is no longer theirs. Even if they sell the contract and it goes straight up in value until expiration so that the trader makes a profit, the hedger still loses that opportunity in an equal amount. I didn't say that they are neccessarily concerned about it. To them, it is the cost of not having to worry about price moving in the opposite direction. There is still a transfer of "wealth" from one party to another that is equally balanced and thus zero-sum (again, ignoring transaction costs). With the exception of the hedger, yes, I am strictly looking at this from a financial standpoint, and not measuring "utility" in every possible form. While the farmer may gain comfort from laying off his risk, there is still a financial loss if he could have sold his corn at a higher price on expiration day in the cash market. All of the speculators that hold the contract before expiration are strictly in it for the money. If not, they have some psychological issues to work through and probably shouldn't be trading.
With regards to expiration, the rollover is done by selling the current month and buying a foward month (if you are long), so someone is still ending up with the contract on the last day and thus the game is finished. Whether its a physical commodity that is delivered or a cash settled contract like the S&P. Either way, the original transaction is settled up that day. It is a contract that the long and short party, whoever they may end up being, are obligated to fulfill.
So I don't disagree with you, but the point of whether life is just a zero sum game is much deeper than I have ever tried to go, I'll leave that to someone with too much spare time on their hands, lol.
Thanks for the interesting discussion.
Kirk