Forex is a market that moves quickly and can offer profitable results if you know what you are doing. But many experts advise novices to reconsider their decision before entering the market due to the inherent risks involved. They contend that trading forex is a zero-sum game in which an expert must win in order for a novice to lose.
It’s not necessarily a zero-sum game in forex. It may be a negative-sum game if you take into account the extra costs associated with using leverage, spreads, swaps, brokerage fees or opening hedging positions. If a trader has the patience to wait for price increases, it might also be a positive-sum game in the long run. As a result, both the seller and the buyer win.
This article examines many situations in which the game of forex can be zero-sum, positive-sum, or negative-sum. Additionally, it discusses how these ideas impact your trade.
What is a zero-sum game?
In a zero-sum game, the benefits of some players are exactly offset by the losses of other players. When one player’s gains are equal to the other player’s losses, the result is a zero-sum game, and the net reward is also zero. Poker is a prime example of a zero-sum game.
A zero-sum game in forex is one in which, for every successful trader, there are a certain number of losers. As an illustration, if you profited $100 on a trade, someone else lost $100. That is the essence of zero-sum.
In essence, this proves that the forex market is Pareto efficient. Pareto efficiency or Pareto optimality is a situation where no action or allocation is available that makes one individual better off without making another worse off. When something is Pareto efficient, it indicates that improving it will always worsen at least one person or another criterion.
In this way, a win-win game, which generates value for both sides, differs from a zero-sum game.
Is forex a zero-sum game?
What has to be determined is whether one person’s gain in a Forex transaction equals another person’s loss. Currency pairs are used in Forex trading. There must be a counterparty who buys or sells that currency pair for every trader. One or more banks, brokers, or other retail traders could serve as these counterparties. The crucial thing to remember is that in order for a trader to win, the counterparty must lose, and vice versa.
By placing bets on how a currency pair will move in the future, traders in forex can profit. A person can profit by closing the trade if they correctly estimate whether one currency will appreciate or decline against another.
Let’s say you believe a currency’s value is declining. The counterparty is a trader who anticipates an increase in the value of that currency. These forecasts can only be one of them. Therefore, if you prevail, the opposition will lose. Forex becomes a zero-sum game at that point.
This isn’t always the case, though. The fact that not all Forex traders engage in speculative trading is one argument against the zero-sum nature of the market. For instance, when traveling, travellers sometimes exchange their local currency for a different one. They are unaffected by market fluctuations while they are away. Therefore, regardless of the relocation, individuals can exchange their additional money back into their own currency once they return.
Forex can also be a positive-sum or negative-sum game in the following scenarios.
The positive-sum game of forex
Is it necessary for someone else to lose money in this market for someone else to be profitable? No, not always.
Consider a day trader who purchases a euro for 1.2600 and sells it the following day for 1.2700. 100 pip profit would have been made in this trade, not taking into consideration broker fees.
What about the seller, then? What if the seller had purchased the currency a few days earlier at 1.2600? They also gained a profit of 100 pip in this manner. Therefore, one person’s success does not imply another’s failure.
One can contend that the seller would have made more money if they had kept their currency and sold it instead of selling it. They were so at a loss. But in trading, where we don’t account for possible losses or gains, that is not logical reasoning. We focus on what happened rather than on how things might have been.
Let’s think about a different circumstance. Let’s say one trader enters a short position on the EUR /USD pair, while another trader opens a long position. For the broker, that is the ideal situation because they can get the spread and maintain a flat position.
There is no necessity for one trader to lose and the other to win in this circumstance. Consider a scenario in which one of them has started a long-term trade and the other a short-term trade. The latter’s short-term transaction might be profitable, but the former need not lose their deal.
Therefore, the initial trader can also profit if they hold out long enough for the prices to turn around. In this instance, the broker as well as both traders profited, demonstrating that forex is a positive-sum game. Therefore, your success need not be someone else’s setback. Instead, the entry of someone else equals the leave of you.
The negative-sum game of forex
Some people contend that forex is a negative-sum game rather than a zero-sum game. According to them, retail traders start trades below zero and not at breakeven because of the broker costs they must pay such as spreads, swaps and commissions. Not to mention, slippage can cause trade delays which can also add to the cost.
Additionally, they assert that not everyone opens a position in order to earn. To protect themselves against risks, some traders open positions. Let’s say someone opens a long position but has worries about the market’s potential to move in that way. To prevent losing money, they open a short position on the same pair. In this case, the trader simply avoids a loss rather than making a profit. It is, however, a negative-sum game due to the fees, commissions, and spreads that they must pay.
Leverage is another factor that results in loss for Forex traders. Leverage is viewed as a double-edged sword by forex traders since it has the potential to either increase your profits or decrease them. In an effort to achieve a profit that you would never be able to make with your initial capital, you borrow money from a broker that is hundreds of times bigger than your investment.
Forex dealers aren’t actually purchasing and disposing of actual currencies, which is an issue. Instead, they participate in currency movements by taking positions.
Leverage of 1:100 allows a trader to purchase an asset worth $10,000 with just $100 as 100 x 100 = 10,000. However, the trader is liable for the full $10,000 if the value of the currency declines. In other words, the trader will lose all of their money if the asset’s value declines by 10%. Therefore, if the trader doesn’t understand how to employ leverage, they risk losing their initial investment.
Why does it matter?
Therefore, depending on the situation, trading in forex might be a zero-sum, positive-sum, or negative-sum game. The trader’s strategy for joining the game will determine everything. Forex, on the other hand, is a zero-sum game in which the overall quantity of money flowing in the market remains constant. When one trader cancels a position in loss, another trader may have closed the same position in profit.
However, there need not be a clear winner or loser in the Forex game because everyone may earn with the right information and experience.
In fact, the majority of Forex traders who lose money are either unskilled or don’t have the capital to endure losses until they turn a profit. These amateurs hope to strike it rich quickly and end up being over leverage and using poor money management techniques.
Therefore, be sure to enter the market with information, abilities, and risk-management tools if you want to win in this game. Be consistent, patient, and disciplined enough to withstand drawdowns and employ instruments like leverage sensibly. In this manner, you may prove that you are amongst the small percentage of retail forex traders who actually make money.
Due to the relatively finite quantity of money that is circulated every day, Forex is a zero-sum game overall. For instance, if you simply consider the transactions of traders A and B, it might not seem to be a zero-sum game. However, if you consider everything, every transaction between traders A, B, C, D, etc. will always result in a zero-sum. Having said that, one could describe Forex as a negative-sum game if transaction costs and broker commissions are taken into account. However, depending on the circumstances, it may result in a win-win or a lose-lose scenario for the trader on either end of the trade. If you have the necessary patience and knowledge, you can become a successful forex trader but I would always start on a demo account to improve your skills and knowledge of the markets.
Self-confessed Forex Geek spending my days researching and testing everything forex related. I have many years of experience in the forex industry having reviewed thousands of forex robots, brokers, strategies, courses and more. I share my knowledge with you for free to help you learn more about the crazy world of forex trading! Read more about me.