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Psychology of the Zero Sum Games

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1Psychology of the Zero Sum Games Empty Psychology of the Zero Sum Games Wed Nov 02, 2016 8:16 pm




The lure of zero sum markets is based on real advantages over equity markets. The tight spreads, quick FIFO order fills, 24/6 trading hours and low margin requirements make futures trading genuinely attractive. There are also tax advantages, as the reporting is much simpler (no wash sale rule) and taxes are typically less for active traders. No wonder many of the famous ‘market wizards’ made their fortunes in the futures markets, not in stocks.

Richard Dennis, for example, the former ‘Prince of the Pits’ who initiated the great Turtle experiment in the early 1980’s, reportedly turned $400 into several hundred million trading commodities in Chicago. Standing right behind the bold Prince, however, was a shy, bookish mathematician named William Eckhardt. The two men had complementary skills that together gave them a unique tactical and psychological edge over the short-term scalping tactics employed by most traders during that time.

Zero sum markets offer an abundant opportunity flow, but they evolve faster than equity markets, so ‘edges’ become harder to maintain. In a 2003 interview published in Stocks & Commodities magazine Richard Dennis noted that trading futures had become “10 times harder now than it used to be.” To further illustrate this point, Larry Williams won the World Cup Futures Championship in 1987 with an astounding 11,376% annual gain.

Ten years later his daughter Michelle won the same contest with a 1000% gain using the same %R techniques. Over the last decade, however, the best futures traders in this contest generally post annual gains between 200% and 600%; substantially less than the Williams’ family attained. Last year’s winner, Michael Cook, netted 366%. Have the futures markets become even more difficult than they were in 2003? I think the answer is ‘yes.’

To participate in the opportunities they offer today requires significant psychological and technical adjustments on the part of aspiring traders, especially those who come to futures from equities. A quick look back at how these markets have evolved may provide some context as to why.


The commodity options and futures markets in the U.S. were originally developed in the mid-1800’s as a place for agricultural professionals (producers, hedgers and large speculators in butter, eggs and grains) to transact business directly with each other. They were conducted on special octagonal platforms via open outcry. The Chicago Mercantile Exchange building, built in 1885, was the largest commercial building in Chicago at the time and the first to have electric lights; a testament to its economic importance.

Until recently, the futures markets were exclusively B2B (business to business) and they still operate without the dedicated intermediaries that manage order flow for equity trading, i.e., the market makers and specialists whose job it is to interface with a wide variety of buyers and sellers (retail and professional) in order to supply liquidity and dampen volatility. No wonder they lack the orderly demeanor associated with equity bourses such as the NYSE.

Although former floor traders boast that futures markets have historically maintained liquidity during a crisis better than the NYSE, they accomplished this feat in a very raw, in-your-face manner. What’s new is that small speculators like you and I are now able to participate in these professional markets from the comfort of our home office. However, the presence of new participants and the migration to an electronic platform has significantly changed the game.

Twenty years ago 99% of futures trading was conducted on ‘the floor’ where a typical professional futures trader might execute 60 trades per hour. Last year, however, floor trading accounted for just 1% of the total futures volume. If you ask a seasoned floor trader about screen trading, most will tell you that it has made their lives more difficult and less profitable. Previously, they were able to see, hear and feel information about the counterparties to their trades, as well as observe the behavior of certain key individuals in the ‘pit.’ In today’s electronic marketplace, however, the players are anonymous.

The counterparty to your last trade could be a private trader like you, or a robot, or a housewife in Japan, or a trader at a fund in Connecticut, or a teenager with a trading app on his phone. (Imagine for a moment that you could actually know.) From a simple business school perspective, participating in a continuous auction conducted by anonymous buyers and sellers raises the following concern: “How does one conduct a profitable trading business when one doesn't know the identity or motivation of the person selling to you or the person you are selling to?” One answer is to simply apply a mechanical method. Richard Dennis succeeded in large part because he partnered with a mathematician and today most math Ph.D.’s are hired by the financial industry.

To research non-discretionary mathematical trading methods further read Trade like a Casino by Richard Weissman. Most traders in zero sum markets, however, are discretionary. Discretionary trading relies on one’s ability to make rational buy and sell decisions in real time, based on one’s assessment of market context and conditions. The more discretionary your method, the more vulnerable you will be to ‘The Game.’

While electronic platforms supposedly level the playing field, they actually give new advantages to the larger participants, and to those capable of building trading bots that can identify and exploit certain very short-term advantages in price action. If you come to these specialized, professional markets from equities, as most aspiring traders do, you will inadvertently bring attitudes, rules, techniques and behavior that are maladaptive within this ecosystem and make you vulnerable to exploitation. Specifically, it’s now common practice for certain players to manipulate price action in a way that induces smaller fish to execute a low-odds entry… and then squeezes them into liquidation (a stop out). (See Fig. A).

As you may have noticed, however, that almost immediately after this ‘wash and rinse’ event, the market will often reverse and resume trading in the original direction. Indeed, zero sum markets operate on principles that are generally the opposite of what you have been taught in books and courses about equity trading. Accordingly, most of what you know and trust about how markets work will be used against you in this environment.

That’s because coming from equities, your mindset and your behavior are predictable. In fact, the more carefully you follow those rules and procedures, the easier it will be for the zero sum ‘natives’ to locate your stops and your Uncle Point (the point of maximum pain). This information will enable these more experienced traders to squeeze you into liquidation. Bottomline, these folks are not trading “the market,” they are trading you. In summary, contrary to what you might read in industry promotional material, the modern zero sum universe is ruled by a rather perverse and paradoxical principle: In zero sum markets, the more you try to be the good and responsible trader you have been trained to be, the more punishment you will receive.


If you are not prepared to think and behave opposite to what works in equities you will often find yourself out of sync with these markets. Since making this shift is difficult to do, the most common psychological effect is a gradual decrease in one’s adherence to a defined trading plan (which doesn’t seem to be working anyway) and an increase in experimentation with alternative strategies. This exacerbates any tendencies you may have to make up stuff on the fly. Or it may have the opposite effect and foster a paralysis of analysis, so you remain on the sidelines or hide out in the Simulator. In the end, however, the psychological effects of being out of sync with the market (too many losses) can wear you down.

For the vast majority, trading these markets eventually becomes a struggle in contradiction: an imperative to put on risk and an equal aversion to losing. The state of self-contradiction will cost you dearly in this game. If doubts and fears are your constant companions, you will hesitate when you need to be bold and act boldly when you should hesitate.

If you are like most private traders your experience with futures has been mean reverting (like the market itself):

  •  You have good days/weeks followed closely by bad days/weeks;
  •  You've enjoyed fantastic run ups and given it all back (more than once);
  •  You over-trade and/or you under-trade;  You risk too much and/or you hide out in SIM;
  •  You constantly try new things and/or you are paralyzed by over-analysis. You have probably been ready to give up, but you can't give up. You have re-funded your account several times. Your family secretly thinks you're crazy and you sometimes agree, but on the other hand, success feels like it's just around the corner. This is the double bind that keeps you awake at night.

The majority of aspiring traders in zero sum markets fail rather quickly. Those who survive the initial shake out are incredibly persistent, but my research data also show no correlation between the number of years one has been trading zero sum markets and one's profitability. Indeed, despite above average intelligence and a lot of hard work, despite previous business success, despite sophisticated software, despite instant access to price data and news, and despite mentoring by successful, charismatic traders... many zero sum ‘survivors’ are stuck at breakeven. Simply spending more time at your screens isn't likely to yield the results you want. In moments of introspection you naturally wonder whether there's something wrong with you.

You've researched trading psychology in order to formulate a plausible self-diagnosis. You ask yourself questions such as:

  •  Am I sabotaging myself due to unconscious programming and limiting beliefs? (Maybe I should try NLP.)
  •  Am I afraid of success even though I've been successful in business? (Maybe I should try hypnosis.)
  •  Am I just not smart enough, quick enough, young enough to make this work? (Maybe I should take smart pills.)
  •  And for Pete's sake, why can't I control my impulses and emotions like a normal person.

Naturally, you are looking for a breakthrough, but in my view, an heroic, all-in, walk-on-hot-coals Tony Robbins style effort is unlikely to do much good. Why? To paraphrase Einstein, one can't solve a trading problem with the same level of thinking that created it. Most individual (retail) traders in zero sum markets can’t solve the market riddle because they operate within a paradigm derived from the respected rules of traditional technical analysis tailored to the equity market. This makes it impossible to recognize the actual rules of the zero sum game, let alone win it.

To succeed in zero sum markets requires a mindshift. Let’s examine some of the ‘non-standard’ technical features of this market and what you can do to avoid getting fooled by the games.

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Regardless of timeframe, zero sum markets are like an alternative universe where the normal laws of physics are suspended, and mostly work in reverse. Instead of Gravity, Momentum and the Pursuit of Gains, one finds a world ruled by the Law of Mean Reversion and the Pursuit of Stops. This is the most important Mindshift you need to make. It’s the opposite of Newton’s first law (objects in motion tend to stay in motion); in this world objects in motion tend to reverse.

Trends do happen, but they don’t necessarily persist and breakouts often fail. The trend-following Turtles generally had only 4-5 profitable months per year. The rest of the time their job was to not lose too much money in the chop. Zero sum markets are psychologically challenging because they demand an extraordinary ability to “go with the (order) flow,” which changes direction frequently and retraces more deeply than equity traders expect.

The 61.8% Fibonacci retracement level, for example, is consistently violated in the futures markets… by just enough to stop out equity-trained pullback traders before the trend resumes. In equities, breakouts after a consolidation (e.g., a cup and handle pattern) usually work, at least in bull markets. Trading breakouts in zero sum markets, however, is semi-suicidal. One reason is that zero sum markets price-in news events very quickly and that sets the stage for almost immediate mean reversion.
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While the novice trader is looking for a way to get in after believing that a new trend is now confirmed by the breakout, professionals are looking for an opportunity to fade this price action and run the breakout trader’s stop. Gotcha! Those with a rigid mentality, strong opinions and a stubborn need to be right have little chance of long-term success in markets that change their mind so often.

Anecdotally, this may be why doctors generally have difficulty trading futures even though they are smart, while pilots and others accustomed to making many mid-course corrections tend to do better. Trading these whippy markets requires flexibility and discipline in equal measure, a fairly rare combination. FYI… my AWARE® Trader Personality Profile, available for free on my website, will give you information about your trader temperament. To get full value, I recommend requesting a free 15 minute consultation on the results.

Like the twin jaws of a vise grip, zero sum markets apply pressure to participants in two ways: time compression and price expansion. These forces work together to elicit liquidation on the part of smaller traders. To prosper in this environment you have to learn to use these two key processes to your advantage. You want to be the squeezer, not the one being squeezed.

There is an intraday (day session) Time Pivot cycle that can turn a simple day session into a much more dramatic 5-act squeeze play:
1. The Open (i.e., the Opening Range);
2. The Morning Reversal;
3. The Mid-day Consolidation;
4. The Afternoon Reversal; and
5. The Close.

Each of these ‘acts’ has a beginning, middle and an ending, which represent opportunities to profit or opportunities to get squeezed. Trading the Open, however, where you are often dealing with gaps, half-gaps, opening ranges, etc., is the trickiest part of the day and is a specialized art. The ‘opening range’ is defined according to the time frame you trade. It could be the height of the first 1 minute bar or the range of the first hour.

If you are not familiar with the various opening range plays (setups), then wait before getting involved. Look for the Reversals 30-60 minutes after the open and before the close. They usually occur a few minutes on either side of the hour or the half hour and they are not the same every day. They are probable, but not reliable. In other words, don’t over-anticipate them. The above list is the general Time Pivot pattern in the index futures, but the pattern is likely to be different in other markets.

What’s important is that you research the time patterns in the market you trade. When the time tide shifts, do your best to recognize it, don’t fight it. If you can do this, they provide some of the best trading opportunities because these reversals seem to come from nowhere and catch many traders wrong-footed. That’s a squeeze that you want to avoid, and hopefully capitalize on.

Time feels compressed in zero sum markets because price action is expanded, especially around these time pivots. The extreme leverage in zero sum markets generates intense pops and drops. It is difficult, however, to filter signal from noise because the magnitude of price action does not necessarily signify a valid trend change. Sudden moves of magnitude do catch our attention at the level of the deep brain, however.

We spent millions of years as hunter gatherers when sudden moves in the environment meant either danger or opportunity. It’s very difficult to turn those reactive circuits off because they stimulate dopamine, a very powerful motivator. You see a wide bar, and a part of your brain sees either danger or dinner. This leads to quick exits or to chasing (buying high and selling low), which is the bane of most novice futures traders. We chase because it’s human nature to assume that the fast move is meaningful; the start of something (objects in motion…). If you buy high or sell low in zero sum markets, however, you are taking a high risk entry.

Sharp spikes are much more likely to be the end of something (exhaustion) and result in mean reversion rather than in continuation. Instead of chasing, aspiring traders must come to terms with the fact that a sharp move means you have probably missed out. If you chase because you have a Fear Of Missing Out (FOMO), it will be an adverse influence on your P&L. At the end of this report you will find an offer that can help reduce that behavior. Suggestion: Develop a method based on low volatility entries (like John Carter’s famous squeeze entry). Because our brain is calibrated to notice sudden moves, it takes some training to recognize moments of equilibrium in the market as significant, but they can be very useful.

Here are some examples of the differences in the two environments (equities & zero sum) with screenshots to illustrate the points. :

Follow these three steps to adapt to this new environment. Step 1. Understand the new game (yes, they intend to fool you.) Step 2. Stop making costly errors due to chasing or other exploitable behaviors. In other words, clean up your act. Practice new behaviors that are exactly the opposite of how your gut and your previous training urge you to behave. Step 3. Develop a trading method (mechanical or discretionary) that takes advantage of the predictable behavioral patterns generated by the mistakes of less skillful traders. That will quickly put you on the winning side of the game.

You now understand more about the nature of the zero sum game. Are you ready to integrate this knowledge into your actual trading? Simply reading about it won’t necessarily make the lasting changes you want, nor will it make them as quickly as you might like. Here’s the most powerful way to catalyze the mindshift required to trade these markets.

What is the [You must be registered and logged in to see this link.] characteristic of great traders? In his book Trading in the Zone, Mark Douglas says simply, “Great traders are not afraid.” I would go one step further. I’ve worked with some of the best traders in the business. I’m talking about guys with unlimited capital, trading six markets at the same time. The one thing that differentiates them is that they are POSITIVE about everything that happens to them and everything they do. This POSITIVE attitude enables them to think clearly, take losses in stride and not be ego-inflated by their wins.

POSITIVE TRADING PSYCHOLOGY: WHY IT WORKS I’m 100% certain that they are not positive merely because they are winning; they win because they are positive to begin with. There is ample evidence from my field of specialization (clinical psychology) and sports psychology to back up this assertion. Most aspiring traders, on the other hand, fall into the double negative trap (not losing, not being wrong, not missing out, not leaving money on the table, etc.), but in real life and in trading two Negatives never makes a Positive. Instead, that subtle, creeping negative attitude actually confuses and demoralizes the brain and most traders don’t realize how negative they have become.

There’s a simple reason traders fall into the Negativity Trap: the human brain is hardwired to pay the most attention to bad news. It increases our odds of survival. Do you remember the joyous moments in trading as vividly as the painful ones? Probably not. And even though you may know intellectually that trading is a probabilistic undertaking and losses cannot be avoided, a critical part of your brain absolutely hopes/believes otherwise.

Indeed, there is a part of your brain (the amygdala) that I call the Risk Manager, that frets about every single loss… and that’s a problem. You will find it difficult to take losses in stride because your Risk Manager’s Prime Directive is to keep you and your family safe and secure. A failure to bring home the “bacon,” or losing the bacon you already had, is something the Risk Manager takes very seriously.

You see, survival isn’t merely an ‘option,’ it’s an imperative, so the attitudes and behaviors that bear directly upon our survival are not controlled by our conscious thoughts, which are variable, but by our instincts, which are invariably reliable. But instincts are narrowly focused all-or-nothing reactions. Because financial losses (of any size) threaten our basic sense of security, they are closely scrutinized by the Risk Manager.

In fact, your brain is programmed to feel the pain of financial loss acutely, so that it has a better chance of avoiding it next time. This can make trading feel like “death by a thousand cuts.” And because the Risk Manager in the brain cannot actually count, I’ve literally seen multi-millionaire traders agonize over a $100 loss!

I’m not making this up. Research studies indicate that financial losses have about 2.5 times the emotional impact compared to the pleasure that comes from winning the same amount of money. This built-in imbalance has huge consequences for your trading. To meet the challenge of zero sum markets successfully, it is imperative that you cultivate a mindset that can quickly rebound from losses, so they don’t create a self-fulfilling cycle of negativity.

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