What Is a Zero Sum Game?
A Zero sum game is any game or activity where a participants gain or loss is exactly balanced with the losses and gains of the other participants. If the total gains are added together and the total losses subtracted the sum will be zero, hence the name zero sum game. Poker is one example of a zero sum game where players can only gain at the expense of other players.
Is Forex a Zero Sum Game?
I have seen a number of debates regarding whether Forex is a zero sum game. Technically Forex is in fact at best a zero sum game as any gains made by one trader are equal to the losses of other traders. As currencies are traded in pairs, if one trader buys one lot in the EUR/USD and another trader sells one lot of the pairing any gains by one trader will be equal to the losses of the other trader. Thus Spot Forex can accurately be described as a zero sum game.
It has been argued that Forex is not a zero sum game as not all participants in the spot market are making speculative transactions. For instance a tourist may swap his Pounds into Dollars and intend to spend all of his Dollars while he is on holiday in Florida. Such a market participant will not care if the market moves against him while is on holiday. This does not change the fact that overall the Spot Forex market is at best a zero sum game as total gains will always be equal to total losses.
For retail traders spot forex is in fact a negative sum game. A negative sum game is any game or activity where the sum of total gains and losses is negative i.e below zero. The reason why spot Forex can be considered a negative sum game is that traders incur substantial costs when trading the currency markets. Brokerages charge a marked up spread or commissions to traders, these mark-ups and commissions are used by the brokerages to cover their costs and to earn a profit. This means that the sum of gains and losses is in fact negative making Forex a negative sum game.
Does It Matter?
Does it matter that Forex is zero or negative sum game? This is where the debate really heats up. Some have alleged that retail traders face the problem of gamblers ruin. In a fair game (one with no information advantages) between two players which continues until one player is made bankrupt, less well capitalized player has a much higher possibility of going bankrupt. It is argued that since the retail trader is speculating against the rest of the market which has vastly more capital the average retail trader is very likely to go bankrupt. This does seem to ring true with it being estimated that around 70-90% of retail traders ending up as losers.
The fact that Forex is a zero sum game doesn’t preclude traders from making money. It simply means that any profits you make come at the expense of other market participants. There is no reason why skilled traders can’t end up making money.
Is All Forex Trading A Zero Sum Game?
When trading is made for the purpose of making fx payments, it’s still a zero sum game because eventually any trader will have to pay spreads on the Buy / Sell of a currency, but since there’s not one trading against you, there’s nothing negative about it.