FX – Zero Sum? Who Cares?

This week FX Street asked me to weigh in debate as to whether the FX market is a zero sum game. The two opposingviews can be found here

Richard Olsen: http://www.fxstreet.com/education/forex-basics/trading-forex-is-a-positive-sum-game/2012/10/31/

John Forman: http://www.fxstreet.com/education/forex-basics/retail-forex-trading-is-a-negative-sum-game/2013/01/17/


So if FX a zero sum game? Of course it is. Just read John Forman’s article on the difference between asset markets and contract markets. FX like all futures markets (including ironically enough those for the Dow and S&P) is a contract based market. You own no assets so you cannot derive any intrinsic appreciation from your investment. Your gains do indeed come from other participants losses.

More importantly FX like all commodities is a bounded market. Even if you were to take delivery of euros, or corn, or even oil -- there is absolutely no reason to believe that your investment will appreciate 10 years forward. Commodity prices are subject to supply and demand forces and therefore will always (unless we reach a terminal point of supply) fluctuate in a range. Equities on the other hand are valued on their accrued income stream which over time can multiply manifold. That’s why between 1970-2000 the Dow went from 1000-10000 but GBP/USD simply oscillated between 1.000-2.000.

So let’s establish once and for all that yes -- FX is a zero sum game because it is a speculative market. And like all speculative markets is simply transfers risk from winners to losers. But I think this point misses the larger picture. Although many investors like to argue that equities are an asset market and are therefore “superior” to FX, in practice stocks act very much like a contract market with all the zero -sum implications of speculative activity.

Stock indeed are assets that should appreciate over the long term. But by long term I do not mean weeks or months or even years, but rather decades and in some cases (are you listening Nikkei) possibly centuries. So yes if you hold stocks for decades you generally have a good chance of making money. But how many investors do that? One out of a million? Perhaps even less. The fact of the matter is that most investors trade stocks in a strictly contractual fashion. They sell when prices go up and sell when prices go down. They chase momentum or try to be bottom pickers.

When it comes to stocks most investors make the pretense of trying to own value when in fact all they care about is the price of the security. Witness the recent price action in AAPL which has more cash on hand than the US government yet is dumped by the market like some two bit retailer on the verge of bankruptcy.

My point is that in our modern world there are no investors, only speculators. Stock guys can give you a very nice story about growth and valuation but at the first sign of price declines they will bail. ( And please no emails to me about how you are all long term holders. Remember -- long term in asset markets is decades, sometimes centuries). So if everyone is a speculator then you might as well trade in the biggest spec market of them all. At least in FX you won’t have any illusions as to where you stand.

Boris Schlossberg

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