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Ask HN: Why be an option/futures/day trader when it is zero-sum?

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Re: Ask HN: Why be an option/futures/day trader when it is zero-sum?

#21

Post by nostrademons »

getp wrote: post #3

The irrationality you are referring to is called the self-serving bias (SSB). I wrote a thesis on overconfidence for my master in behavioral economics, and the two are related. SSB is a well-documented bias. For instance, 90% of American drivers think they are in the top 50%. It's hard for people to fully appreciate this fact. Allow me to illustrate. Do you still consider yourself, even after reading this statistic,…

90% (actually, about 98%) of American drivers are above average, owing to a statistical quirk. There are 6 million car accidents in the U.S. each year, out of roughly 240 million vehicles. At a minimum, that means that 97.5% of drivers get in no accidents that year. They join the big bulge of people who are "average", having perfect driving records or only an accident a decade or so.

Accident frequency is a power law distribution - a large percentage of crashes are caused by a small number of drivers who habitually violate traffic laws, drive drunk, or otherwise engage in risky behavior. One of the distinctive features of power law distributions is that there's this long tail of people with very small values, and then a few people who make up most of the curve. So (made up numbers) you might have 60% of the population who has never gotten in an accident, then 35% who has gotten in one, then a tiny fraction of 1% who's been in a dozen. Over an 80 year lifetime, that 6 million accidents/year results in 480 million accidents, or 2/person, so with the hypothetical percentages above, 95% of people are above the mean and 60% are above the median.

Just goes to show that you can't assume everything is a Gaussian. ;-)

A similar phenomenom occurs in many, many other fields. The average (median) wage-earner actually makes below average (mean) wages, because the existence of Bill Gates and Carl Icahn skews the distribution upwards. The median sale price for a startup is $0, because over half of them fail. The average test scores in Palo Alto or Weston, MA or Hunter College High School really are above average, because those places already preselect for bright kids. It's quite possible for Lake Wobegone to exist: you just need to compare your kids with someone else's average.

And none of this invalidates SSB, but you picked a bad example to illustrate it. When 90% of drivers think they're in the top 50%, they're right.

Re: Ask HN: Why be an option/futures/day trader when it is zero-sum?

#22

Post by yummyfajitas »

hugh wrote: post #13
Tichy wrote: post #10

I am not sure that traders don't create value. Their job is to allocate money to the most useful company, I suppose?

Except the companies don't see any of the money once the IPO is finished. Of course, the only reason the IPO can proceed is because people who buy shares know that they can sell them to other people later. So I suppose in that sense they help. However, once the market already exists, no extra value is created by an extra trader entering it. As others have pointed out though, there genuinely is value created by the op…

Well, companies do sometimes make further public offerings.

Stock trading also provides a somewhat objective measure of the value of the company. For instance, if MS wants to buy Yahoo, how much should they offer? Without the stock market, it's tough to tell if they are lowballing or paying a premium.

Re: Ask HN: Why be an option/futures/day trader when it is zero-sum?

#24

Post by muerdeme »

brentr wrote: post #18
muerdeme wrote: post #15

Earlier quoted context omitted.

My understanding is the "speculators" create liquidity for the risk managers, thereby assuming their risk. Why does the money leaking via commissions necessarily make the game sub-zero sum? Is it because we aren't looking at the big picture where everyone wins? It seems like the risk managers must have a positive incentive to sell their risk on the marketplace instead of assuming it themselves. I.e. hedging another i…

I was thinking about how to better answer your question concerning the sub-zero game statement I made. Let's remove ourselves from finance for a minute into something that is more traditional in the game theory studies--namely poker. If the game is played where the players arrange transfers face to face such as in a home poker game, then the game is zero-sum. Your losses are my gains. No money is created. No money is…

I was thinking that, because the market created value, it couldn't be zero or negative sum. Now I realize that it's negative sum within the scope of the market itself, even though it may create value in a grander scheme of things.

Re: Ask HN: Why be an option/futures/day trader when it is zero-sum?

#25

Post by brentr »

muerdeme wrote: post #24
brentr wrote: post #18

Earlier quoted context omitted.

I was thinking about how to better answer your question concerning the sub-zero game statement I made. Let's remove ourselves from finance for a minute into something that is more traditional in the game theory studies--namely poker. If the game is played where the players arrange transfers face to face such as in a home poker game, then the game is zero-sum. Your losses are my gains. No money is created. No money is…

I was thinking that, because the market created value, it couldn't be zero or negative sum. Now I realize that it's negative sum within the scope of the market itself, even though it may create value in a grander scheme of things.

To truly understand the implications of game theory applied to the financial markets, you should look up the concept of Pareto improvements and Pareto optimums.

Re: Ask HN: Why be an option/futures/day trader when it is zero-sum?

#26

Post by xlnt »

speculation done right consists of creating knowledge about what resources will be in what demand in the future, and then saving resources that are cheap now but will be expensive later. doing this raises the price a bit now (b/c you buy a bunch) and lowers it then (b/c supply is higher then). you make money smoothing out price fluctuations. this is a valuable service -- price fluctuations can really hurt people or companies that don't have spare money at the moment.

there is a limit on how much total money can be made doing this. the more people do it, the less price fluctuations are available to even out.

but anyway, there are good types of trading.

Re: Ask HN: Why be an option/futures/day trader when it is zero-sum?

#27

Post by davidmathers »

Zero-sum depends on your perspective. Speaking strictly in theory here: a successful speculator creates value in the same way a hunter creates value when he sharpens his spear. By taking decision making power (money) away from people who make wrong decisions he "sharpens" the market and makes it a more useful tool when other people use it to create value.

Re: Ask HN: Why be an option/futures/day trader when it is zero-sum?

#28

Post by paulgb »

nostrademons wrote: post #21
getp wrote: post #3

The irrationality you are referring to is called the self-serving bias (SSB). I wrote a thesis on overconfidence for my master in behavioral economics, and the two are related. SSB is a well-documented bias. For instance, 90% of American drivers think they are in the top 50%. It's hard for people to fully appreciate this fact. Allow me to illustrate. Do you still consider yourself, even after reading this statistic,…

90% (actually, about 98%) of American drivers are above average, owing to a statistical quirk. There are 6 million car accidents in the U.S. each year, out of roughly 240 million vehicles. At a minimum, that means that 97.5% of drivers get in no accidents that year. They join the big bulge of people who are "average", having perfect driving records or only an accident a decade or so. Accident frequency is a power law…

Sure, but that only works because you've chosen a discrete measure of how "good" a driver is. If you defined a "good" driver by some other measure (say, a function of risky behavior and fuel consumption), then 50% of drivers would be above the median and 50% would be below, by definition.

Re: Ask HN: Why be an option/futures/day trader when it is zero-sum?

#29

Post by davidmathers »

davidmathers wrote: post #27

Zero-sum depends on your perspective. Speaking strictly in theory here: a successful speculator creates value in the same way a hunter creates value when he sharpens his spear. By taking decision making power (money) away from people who make wrong decisions he "sharpens" the market and makes it a more useful tool when other people use it to create value.

Of course I totally missed the point of the question. It strikes me as just a matter of personal temperament. I, personally, have no interest in jobs that involve going into battle againt other people every day. But if that sounds appealing to you then I think you should go for it, even if probability says you won't succeed. Passion > reason.

Re: Ask HN: Why be an option/futures/day trader when it is zero-sum?

#30

Post by byrneseyeview »

It isn't zero sum, any more than manufacturing is zero sum because all you did was expend energy rearranging the same old atoms.

Trading well requires you to synthesize information that other people will act on. If oil is too cheap, you buy oil, this raises the price and alleviates the problem. The fact that this causes some people to lose money is material, but it just means that trading is a way to redistribute wealth from people who are usually wrong to people who are usually right. I do not see how anyone could believe that this isn't socially useful.

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