Wednesday, February 20, 2013

The trader's source of profits

While I was meditating by the river today, I thought about how traders exactly profit from the market. In order for a trader to win, someone else must "lose", right?
To a large extent, this is true. However, the market is an open system with a large variety of players, and not all players are profit-driven. Here is a (most-likely partial) list of profit sources for a trader:
  1. Negative-edge traders. These traders have a negative expectancy. Perhaps their trading methodology is flawed, or they may even have no methodology at all and are simply gambling. Whatever the case, every time they put on a trade, someone else profits. Unless they inject new funds regularly, these traders eventually blow up or quit.
  2. Risk-unmanaged traders. Trading is all about risk management. These particular traders may have a successful trading system or methodology, but end up losing due to poor risk management. They may risk too much per trade. They may only concentrate on only one system or currency pair. While they may have a positive edge on paper, some sort of systemic risk puts them in peril of blowing up.
  3. Discouraged positive-edge traders. I suspect that this is a significant source of profit. Even traders with a positive edge will encounter a nightmare period of drawdown during their career. If these traders become discouraged and quit the market permanently, their losses are crystalised into someone else's profit.
  4. Commercial players. These guys enter the market either to hedge prices or to accumulate forex reserves for their operations. Their actions on the forex market are not profit-driven, per se. This may grant traders an edge over commercial players, especially during large orders that move the market (every pip that moves against a commercial player equals profit for the counter-party i.e. traders).
I thought about including central banks and governments and the games they play, but these entities simply print money (or confiscate them from private citizens). When you profit from these entities, they're not really "losing".
Anyway, I threw this list out there. What other ways do traders profit from the market?

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