I go short on the NZD/USD. In order for me to do this, I require someone to take up the long side of that position so that the brokers can write them off against each other.
When I decide to close this position, I’m essentially taking the long position. So to close I need someone to take over my short position.
In order for me to make a profit, the guy who took up the long side has to make a loss, or hold on to the position long enough for the guy who took over my short position makes a loss.
This makes sense to me. Someone or Someone’s win, and in exchange someone or someone’s lose. Exclude the trading costs and you end up with Net $0 profit. This is why Forex is a Zero Sum Game.
What I don’t understand, and what I’m hoping someone can explain to me is; if the above is all correct, how come I can read things like “44% of positions are long and 56% are short.” (this was in a fxstreet article last Friday about the NZD/USD, but similar statements crop up all the time)
If for me to go short someone has to go long, and for me to close someone has to go short, how is it possible that the shorts vs longs are skewed/unequal?
Thanks in advance for helping me understand that little bit more.
In the retail spot forex market (our market), longs (incorrectly referred to as “buyers”) do not transact business with shorts (incorrectly referred to as “sellers”). Instead, every retail customer (long or short) deals directly with a retail forex broker. Your broker has the other side of every trade you place. In forex lingo, we say that your broker is your counterparty. And he continues as your counterparty for the duration of your trade.
Whenever you take a long position, you automatically put your broker in a short position. And whenever you take a short position, you automatically put your broker in a long position. He may not want to be in the position you have put him in, and there are a couple of things he can do to eliminate his “exposure” to your trade.
Typically, your broker will offset (hedge) his exposure to your position by taking an identical position with one of his liquidity providers. So, if you go long, placing your broker in a short position which he doesn’t want to be in, he simply goes long the same pair and same position size with one of his banks, or with an ECN. In other words, he mirrors your trade exactly, and he does this essentially instantaneously when you place your trade, so that his market risk (his exposure to your trade) is nil.
Your broker is a market-maker in the sense that he offers to “sell” to any customer willing to pay his ASK price, and he offers to “buy” from any customer willing to accept his BID price. There is no requirement that the number of customers willing to “buy” must equal the number of customers willing to “sell”. And, in theory at least, there could be a huge disparity between the percentage of “buyers” and the percentage of “sellers”.
So, is there a “buyer” for every “seller”? Yes, but it’s not the “buyer” you’ve been led to believe. For every customer who “sells”, the “buyer” is his broker. And for every customer who “buys”, the “seller” is his broker.
If you’re wondering why I persist in putting “buy”, “buyer”, “sell” and “seller” in quotation marks, it’s because there is NO buying or selling in retail spot forex. Use the SEARCH feature on this forum to find lots of posts discussing the “buying/selling” issue, if you’re interested in more in-depth understanding of this subject.
As for the “zero-sum” question, if you succeed in taking x-number of dollars out of the market, somebody somewhere had to put those dollars into the market. That somebody could be (1) another retail customer, (2) your retail broker (if he left himself exposed to your trade), (3) an institutional trader, (4) a corporation with an actual economic interest in the foreign exchange market (as opposed to the speculative interest of all retail traders and most institutional traders), (5) a major bank trading for its own account, etc.
Whoever that “somebody” is, he paid you your winnings, and the two of you are part of a zero-sum game.
Net position figures like sentiment indexes are only the numbers for certain groups of market participants. You are right, the net position of all market participants is flat.
Forex (and futures) are zero sum games when considered in isolation in the same way that the insurance business can be considered a zero-sum game: for every win there is a opposite and equal loss. But when considered in the context of the broader economy, the forex business enables massive economic gains by facilitating international trade and the mitigation of currency risk to providers of international goods and services. Thus, the overall effect of the forex business to the global society is a massive net-positive economic gain just like insurance or futures contracts.
That makes a whole lot more sense now. I hope. Of someone asked me to sum it up in a sentence,(which I’d only be able to do if I’ve understood you correctly) would it be accurate to say: "The entirety of the Forex Market is a zero sum game, but the retail spot forex market isn’t necessarily."
That skips massive amounts of relevant information, but would that work as a topic sentence of sorts?
I do understand that you’re not actually buying/selling anything, but having never studied commerce or finance at any level, it’s all a mystery to me. The whole topic seems incredibly interesting and something that, as a trader, I should be aware of.
I’ll look further into it. After all; the more you know the more you know, right?
• the spot forex market (retail plus institutional) is, to all intents and purposes, a zero-sum game, because it is a purely speculative market which is largely disconnected from the overall foreign exchange market; however…
• the overall foreign exchange market absolutely [B]is not[/B] a zero-sum game.
A quick perspective on relative sizes. The retail spot forex market amounts to less than 3½% of the overall foreign exchange market (by volume). Retail and institutional spot forex [I]combined[/I] amount to only about 9% of the overall market (by volume).
Most of the transaction volume in the foreign exchange market (i.e., the 91% that is [I]not[/I] spot forex) involves entities such as multinational corporations [I]which have an economic interest in exchanging one currency for another.[/I]
For example, Toyota exchanges U.S. dollars (earned selling cars in the U.S.) for yen, in order to repatriate their profits back to Japan. In this example, Toyota is literally buying one currency (yen) and selling another currency (dollars), and the parties to this transaction (Toyota and one or more banks) are all “winners”, because they all get what they want at a price they have all agreed to. This transaction is not a zero-sum transaction.
We retail forex traders, on the other hand, are speculators. We have no economic interest in the currency transactions we enter into, [I]except[/I] to make a profit from a change in price. In that regard, our reason for being in this market is no different from a gambler’s reason for being in a card game.
A market in which every participant is a speculator would be a zero-sum game, by definition, just as a card game in which every player is a gambler is a zero-sum game, by definition. In each case, it’s impossible for any participant to win, without causing one or more of the other participants to lose.
I’ve drawn an analogy between speculating in the spot forex market and gambling in a card game. Admittedly, it’s not a perfect analogy; but, it serves to illustrate a point. You and I are not in this market to help Toyota exchange dollars for yen — facilitating world commerce is not on our minds. And creating new wealth is not our motivation.
Instead, we are all about [I]re-distributing[/I] wealth. You are in this market to take money away from me (or some other loser); and I am in this market to take money away from you (or some other loser). To the extent that this defines the business we are in, our business — the retail spot forex business — is simply a zero-sum game.
When they say that 40% are short and 60% are long, as an example, they mean that out of the whole open interest 40% are short and 60% are long. You find this in the Commitment of Traders in the currency options market.