Zero Sum Trading: Trend Following Principle
Lawrence E. Harris (site) the Chair in Finance at the University of Southern California:
"...winning traders can only profit to the extent that other traders are willing to lose. Traders are willing to lose when they obtain external benefits from trading. The most important external benefits are expected returns from holding risky securities that represent deferred consumption. Hedging and gambling provide other external benefits. Markets would not exist without utilitarian traders. Their trading losses fund the winning traders who make prices efficient and provide liquidity."
On any given market transaction, the chance of you winning or losing may be near even, but in the long run, you will only profit from trading because you have some persistent advantage (read: mathematical edge) that allows you to win slightly more often than losing (source: Larry Harris, "The Winners and Losers of the Zero-Sum Game: The Origins of Trading Profits, Price Efficiency and Market Liquidity"). If you have ever played poker or studied edges in gambling, the words of Larry Harris ring true:
"To trade profitably in the long run, you will know your edge, you will know when it exists, and you will exploit it when you can. If you have no edge, you cant trade for profit. If you know you have no edge, but you are trading for other reasons, you will lose."
The players in markets who lose over the long run are generally commercial hedgers. The reason for this is that hedgers use the markets for risk insurance, and insurance premiums always cost money. Of course, other speculators with bad strategy can provide winners with their gains too. As counterintuitive as it seems, if you buy higher highs and sell short lower lows, and you use solid money management to manage and exit trades, you can find a mathematical edge in the long run. This keeps you opposite hedgers as much as possible. It is not rocket science by any means, but it holds up over time very robustly (source: Dave Druz interview with Covel, 2011).
The market is brutal. Forget trying to be loved. Need a friend? Get a dog. If you are going to win, someone else will lose, either through their hedging or their bad strategy. Does survival of the fittest make you uneasy? Stay out of the zero-sum game. Buying high and selling low, over the long run, keeps you opposite hedgers who eventually pay for the privilege of transferring their risk to the markets (source: Dave Druz interview with Covel, 2011).
Read the Zero Sum white paper (PDF). That free report is mission critical to understanding zero-sum trading.
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