Fellow Forex trader Ed Ponsi argues that Forex trading is not a zero-sum game. I disagree with him and sent a rebuttal. The publisherhas not responded so I am reproducing the rebuttal here.

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IS FOREX TRADING A ZERO-SUM GAME?

Andrew J. Chalk

In a recent article (http://www.optionszone.com/learn-more/ed-ponsi/2009/03/is-forex-trading-a-zero-sum-game.html?sid=BR2135&en=1235844) Ed Ponsi made the claim that “There is a misconception among some traders that every trade must have a winner and a loser. There is a great deal of misinformation out there, and there have even been books published recently that incorrectly state that Forex trading is a zero-sum game.”

To prove his argument he used the following example:

“…suppose you enter a long position on EUR/USD and at the same time, another trader takes a short position in the same currency pair. The broker simply matches the orders and collects the spread. This is exactly what the broker wants, to keep the entire spread and maintain a flat position.

Does this mean that in the above scenario one party has to win, and one must lose? Not at all, in fact both traders can win or lose; perhaps one has entered a short-term trade and the other has entered a long-term trade. Perhaps the first trader will take a profit quickly, but there is no rule that states the second trader must close his trade at the same time.

Later in the day, the price reverses, and the second trader takes his profit as well. In this scenario, the broker made money (on the spread) and both traders did, too. This destroys the oft-repeated fallacy that every Forex trade is a zero-sum game.”

Let us go through this argument using cable as the instrument to create a concrete example. We will do the math on the way to see who is making money, who is losing money, and who is flat.

First, consider the case where there is a broker-dealer in the middle. This is not only typical, it helps to clarify the argument.

Cable is at 1.50

Trader A sells short cable. The dealer is now long cable.

Cable goes to 1.00

Trader A covers his short. He is now flat cable. The dealer is now short cable..

Trader B maintains his long position in cable. However, he is down 0.50

Cable goes to 2.00

Trader Bsells his cable position. He is now flat cable. The dealer is now flat cable.

The wealth positions of the parties are now:

Dealer: -1.00. He lost 0.50 to Trader A when cable went down from 1.50 to 1.00. He lost 0.50 to Trader B when cable went back up, past 1.50 to 2.00.

Net result: Dealer loss = Trader A’s profit + Trader B’s profit.

Forex is a zero-sum game.

Second, consider the case where there is no dealer. Trader A and Trader B still exist.

Cable is at 1.50

Cable goes to 1.00

Trader B maintains his long position in cable. However, he is down 0.50

Cable goes to 2.00

Trader B sells his cable position. He is now flat cable. However, he cannot sell to Trader A, per Ponsi’s example, so let’s say he sells to Trader C. Trader C is now flat cable.

The wealth positions of the parties are now: