If you’re a trading currency, you might be wondering if Forex is a zero-sum game. This guide covers just that. Continue reading to learn if Forex is a zero-sum game, what zero-sum game is, why it matters, and much more.
Is Forex a zero-sum game?
For the most part, the forex market is a zero-sum game, which means there is an equal loser for every winner. However, depending on the situation or your point of view, traders may not consider Forex trading a zero-sum game.
If you want to take advantage of the opportunities presented by the forex market, then it’s vital that you know what you’re doing and that you have a strategy.
Traders can use many different strategies when trading currencies; some are more appropriate than others, depending on your goals.
There are no free lunches in foreign exchange, but it is feasible to win over the long haul if you have an edge and take calculated risks.
Why it Matters
Many people have likened the forex market to a zero-sum game, and rightly so. However, depending on the specific situation, that may not be the case.
Free lunches and zero-sum games are useful metaphors for forex, but they only tell part of the story.
The forex market is one in which currencies are traded. Historically, this was done exclusively by large financial institutions that regularly dealt with vast sums of money where commissions were measured in dollars instead of pennies.
Today forex trading is open to anyone with an Internet connection, and commissions are in fractions of a percent rather than in decimals of a dollar.
That means a vast majority of traders are looking for a quick profit at the expense of other Forex traders, which is essentially a zero-sum game. In other words, what is lost is gain by others.
However, businesses that transact internationally often complete Forex trading as a necessary step of a transaction. In this case, their goal isn’t also to make a profit from currency exchange.
What is a Zero-Sum Game?
Before delving into the debate of whether or not Forex is a zero-sum game, let’s define exactly what that means first.
A zero-sum game is one where the gains of some participants are precisely equal to the losses of others.
An example of a zero-sum game is when one player’s winnings are equal to the other player’s losses, so the net payoff is zero. A typical zero-sum game example is the game of poker.
In forex, a zero-sum game means that for every forex trader that makes a profit, another forex trader loses an equivalent amount. For example, if you made $50 off a trade, someone else lost $50. That is zero-sum in a nutshell.
This essentially means that Forex is a Pareto efficient market. If something is Pareto efficient, it means that a situation cannot be improved without making at least one individual or another criterion worse.
When Forex is a Zero-Sum Game
Many traders view Forex trading as a zero-sum game when currencies are spot traded. Traders always trade currencies in pairs, like the euro for the U.S. dollar. In this case, someone could be selling the euro at a profit, and another forex trader is buying it at a loss.
However, not all Forex traders participate in spot market trades with these types of speculative transactions.
Why Some Argue That Forex isn’t a Zero-Sum Game
The majority of Forex trades that occur every day are made by international corporations that export or import goods and services from other nations.
When these transactions occur in different currencies, they have to be exchanged, usually at the time of the transaction.
These types of transactions and currency exchanges are necessary to the business’s operations, and they don’t care about the spot market at the time of their transactions.
However, the total gains and total losses in the spot market are still equal despite the participant’s intent.
Other Examples Against Forex Being a Zero-Sum Game
Some traders often use false assumptions and allegories to demonstrate that Forex is not a zero-sum game. For example, they may state:
Trader A buys currency ABC for $100 and sells it later on for $150 to Trader B. Trader B then sells it for $200 to Trader C and so forth. They may claim, “See, everyone here made a profit! Therefore, it is not a zero-sum game!”
However, they leave out the fact that Trader A originally bought the currency from Trader D, who may have sold at a loss. These types of hypothetical scenarios throw on horse blinders and only focus on a small slice of the whole story to support their viewpoint.
Other Factors to Consider
There are various factors Forex traders should consider when considering if Forex is a zero-sum game.
Here are some top considerations.
Another factor to consider is commission and transaction fees made by brokers. If you are exchanging currencies, you almost always have to use a broker. A broker converts your currency to another and facilitates the transaction between you and another trader.
The broker has employees and infrastructure that all cost money to maintain. As such, they have to charge a fee to keep the lights on, pay their employees, and make a profit.
With this consideration, Forex trading is more akin to a negative sum-game as both buyers and sellers have transaction costs they have to pay.
However, they usually pay the same transaction fees making what the buyer and seller lose equal.
Long Positions vs. Short Position Forex Trades
Some may claim that if two individuals trade with each other and sell at different times that they can both “win.” One enters in a long position and the other in a short position.
In this example, the short-term trader (Trader A) sells $5 to the long-term trader (Trader B) for £10.
- Trader A holds the £10 for two weeks and sells it for $7, making $2 or 40%.
- Trader B holds the $5 for one year and sells it for £14, making £4 or 40%.
Both Trader A and Trader B both made a 40% profit, so Forex trading must not be a zero-sum game, right?
This is another example that is not considering the whole story. This perspective falsely assumes that Trader A and Trader B are the only traders in the market.
It does not include who Trader A and Trader B sold to when they exited their positions to each make their 40% gains.
In this case, Trader A could have made their 40% at the expense of Trader C’s loss. And the same can be said for Trader B, who made their 40% profit at the expense of Trader D’s loss.
Forex trading is a zero-sum game as a profit in a currency trade always equals a loss somewhere on the other side of the equation. The balance may not equal zero immediately, but will be somewhere down the line and history of transaction.
For example, if you only look at traders A and B’s transactions, it may not appear to be a zero-sum game. But if you look at the whole picture, all the transactions between traders A, B, C, D, etc., will always equal a zero-sum.
With that said, if you take into account transaction fees and broker commissions, you might call Forex a negative-sum game.