Trading is a negative sum game, relative to a benchmark.

 The Fundamental Truth of Trading is definitionally true for trading futures.  

The benchmark for futures trading is zero.  For someone to make money, someone else has to lose money.  This would be a classic example of a zero sum game.  Trading futures is a negative sum game because of all the transactions costs.  If there were no transactions costs, and you added up the money made and lost trading futures by all participants, the sum would be zero.  My estimate is that there are over 3x as many losers as winners in futures trading, because of transactions costs.  Think about that… at least three out of four people trading futures are probably losing money.  A quick Google search would lead you to many sources citing less than 1 in 10 being able to be “successful” trading futures.  I don’t want to get into the details of such estimates – just know that the odds are not in your favor.

The Fundamental Truth of Trading is also true when trading stocks or bonds.

The benchmark for these investments are not zero, but some ex post function market performance.  If you assume stocks rise over time and you earn carry on bonds, then these investments could be considered more attractive than futures, since the benchmark could be positive.  However, it is still the case that for you to beat the relevant market benchmark, you need someone to underperform the benchmark.  This will also be a negative sum game (relative to the benchmark) because of transactions costs.  My estimate again is that over 3x as many traders in these investments also underperform their benchmark.  As one example, according to a Money article, 89% of active large-cap fund managers underperformed their benchmark over the past 5 years, and 82% underperformed over the past 10 years.  These are supposed to be the pros!  

Why do so many people actively trade?  

Well, it’s obviously because they are all part of the less than “1 in 4” that succeed in beating their benchmarks!  Obviously!  There is something called “illusory superiority.”  Here are some examples:

  • 93% of US drivers think they are in the top 50% of drivers.
  • 90% of the faculty at the University of Nebraska (presumably smart folks) rated themselves as “above average.”
  • 87% of Stanford MBA students rated their academic performance as above the median.

Since it is not possible for more than 50% to do better than the median, there are obviously many people out there with very poor judgement.  Are you one of them?  For the majority of people, they are going to be much better off just investing in a benchmark fund.  There is no shame in making the sound decision to passively invest.  This is especially true when you consider that you need to do much better than the benchmark, to make up for all the time and expense you will be spending actively managing your money.  All other things being equal, you might as well just invest in the benchmarks, and do something more productive and fun.

The bottom line

The point of this is not to make you feel bad.  I just want you to get a fresh perspective on the negative sum trading game you choose to be in.  Because only when you have that perspective can you make the big strategic decisions that are going to help you become successful.  Most people think trading is all about deciding what to buy and sell.  It is, on a micro level.  But before you get there, you need to first think about some of the bigger strategic considerations that are going to allow you to become successful in the negative sum game where most are mathematically going to fail.  Consistent success is a very attainable goal.  This Philosophy of Trading section attempts to get you started that journey.