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Who is the final bill payer of stock index futures in this zero sum game?


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Who is the final bill payer of stock index futures in this zero sum game?

  #1 (permalink)
 i9506353 
Macau, China
 
Experience: Beginner
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What I mean is a lot of financial product do have a final buyer who pay the bill of its product. For example, government bond do have lots of buyer to purchase what ever the yield rate is, even the yield rate is negative, such as different countries' central bank and pension fund(political reason). Forex do have lots of corporations use it for hedging and central bank purchase it to stabilize the economy. Crude oil and other commodity is the same, the corporation will pay the bill higher bill and the retail customers to spend more money to pay the bill. Therefore, they would be the party who pay our bill while we makes the profit at futures market. However, I can't think any reason on stock index futures. Other than the fund manager who will do hedging. They are the group of people who are more professional than us, which make our edge more harder to win in term of speculation in stock index futures. Do anyone know any of the participants that we can take the edge on, like what I have mentioned at the above example (central bank and pension fund's money)?

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  #3 (permalink)
 tpredictor 
North Carolina
 
Experience: Beginner
Platform: NinjaTrader, Tradestation
Trading: es
Posts: 644 since Nov 2011


Hello,

First, I have already proven that that equity index futures is not a zero sum game. I proved this because it is possible for a HFT firm to arbitrage your futures contract against the stock market. If the stock market has upward bias/drift then whoever they arbed it against can win and you can win. Now, this is a theoretical and tends to be more true on longer holding periods. The futures market is more generally a negative sum game after all fees,expenses, etc.

However, it does not mean that whoever one trades against must lose for you to win. This is false logic. Most of your trades are always going to be matched against HFT which is obviously not going to lose regardless of whether you win or lose.

The idea that you can trade by knowing what pros will do might be silly because most "professionals" cannot trade. If you have any doubt, please refer to the facts of CTA and hedge fund returns. It means even if you knew a CTA trading edge, it would not help you if you want to make what most retail traders want to make.

This brings up another point. Your whole idea of looking at the market may be wrong. Why? Because, it is premised on the idea you only have to beat one participant when in reality to win you have to PREDICT what the market in aggregate will do. It means all participants.

Why is this? Let us imagine a retail trader has a stop loss and you will take other side of his stop loss. The HFT will get the order first and flip it if the market doesn't continue. But, if it continues, you will get the fill. Now, let's say that even majority of his stops are bad -- you would only get filled on the the "good" ones, bad for you.

The question is though where the retailer edge comes from. A tiny bit of edge might come from smaller trading size but probably not hugely relevant for futures market.

The real source of retail edge comes from ability to take directional risk. You see this is why the market is so predictable (at times) because other participants refuse to trade directional risk. The uncertainty is why it is fair. Most hedge funds will not seek to trade outright edge. Many HFT firms will not trade against you because it is becomes a statistical/empirical edge-- statistical edges are not as good as fundamental, mathematical, and theoretically proven edges. Nobody wants a statistical edge! That is nobody who has access to structural, mathematical, etc. edges want empirical edges. Obviously, the majority of all traders only have access to statistical sort of edges-- so that's the best we have.

Now when we think about competition, competition is only possible when both participants have accurate knowledge. What this means is that the market becomes more competitive with edges that are more certain and less competitive with edges that are less certain.

The real edge and reason skilled retailers can not just match but yes beat most professionals is they take directional risk. Directional risk has high uncertainty. So, there is less competition. There is a need to balance this out. It is the uncertainty of the proposition that most retailers do not understand which is why we often blow out. Most professionals are much more strict and serious about risk management. Because, the edge is uncertain you can never know what your return will be even.

Why can futures traders make so much then? Leverage. It is very easy for the edge to be magnified which also magnifies any variances in the edge. I like to think of each trade as having R value. Let's say you risk $300 per trade and you made $1,000. $1,000 sounds a lot (for most of us). But $1,000 is less then 4R. It means you are only 3 losers from being back to ~ break even and 4 from being at a loss.

With day trading, you need to capture higher R multiples and maintain a decent win ratio. In a nut shell though, successful retail trading is basically about taking directional risk at opportune times more skillfully then the aggregate market as a whole and finding some ways to capture at least some higher R trades.

This is just one idea. Note to self, I might disagree with this in the future.

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  #4 (permalink)
 i9506353 
Macau, China
 
Experience: Beginner
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Trading: Eurusd gbpusd AUDUSD
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tpredictor View Post
Hello,

First, I have already proven that that equity index futures is not a zero sum game. I proved this because it is possible for a HFT firm to arbitrage your futures contract against the stock market. If the stock market has upward bias/drift then whoever they arbed it against can win and you can win. Now, this is a theoretical and tends to be more true on longer holding periods. The futures market is more generally a negative sum game after all fees,expenses, etc.

However, it does not mean that whoever one trades against must lose for you to win. This is false logic. Most of your trades are always going to be matched against HFT which is obviously not going to lose regardless of whether you win or lose.

The idea that you can trade by knowing what pros will do might be silly because most "professionals" cannot trade. If you have any doubt, please refer to the facts of CTA and hedge fund returns. It means even if you knew a CTA trading edge, it would not help you if you want to make what most retail traders want to make.

This brings up another point. Your whole idea of looking at the market may be wrong. Why? Because, it is premised on the idea you only have to beat one participant when in reality to win you have to PREDICT what the market in aggregate will do. It means all participants.

Why is this? Let us imagine a retail trader has a stop loss and you will take other side of his stop loss. The HFT will get the order first and flip it if the market doesn't continue. But, if it continues, you will get the fill. Now, let's say that even majority of his stops are bad -- you would only get filled on the the "good" ones, bad for you.

The question is though where the retailer edge comes from. A tiny bit of edge might come from smaller trading size but probably not hugely relevant for futures market.

The real source of retail edge comes from ability to take directional risk. You see this is why the market is so predictable (at times) because other participants refuse to trade directional risk. The uncertainty is why it is fair. Most hedge funds will not seek to trade outright edge. Many HFT firms will not trade against you because it is becomes a statistical/empirical edge-- statistical edges are not as good as fundamental, mathematical, and theoretically proven edges. Nobody wants a statistical edge! That is nobody who has access to structural, mathematical, etc. edges want empirical edges. Obviously, the majority of all traders only have access to statistical sort of edges-- so that's the best we have.

Now when we think about competition, competition is only possible when both participants have accurate knowledge. What this means is that the market becomes more competitive with edges that are more certain and less competitive with edges that are less certain.

The real edge and reason skilled retailers can not just match but yes beat most professionals is they take directional risk. Directional risk has high uncertainty. So, there is less competition. There is a need to balance this out. It is the uncertainty of the proposition that most retailers do not understand which is why we often blow out. Most professionals are much more strict and serious about risk management. Because, the edge is uncertain you can never know what your return will be even.

Why can futures traders make so much then? Leverage. It is very easy for the edge to be magnified which also magnifies any variances in the edge. I like to think of each trade as having R value. Let's say you risk $300 per trade and you made $1,000. $1,000 sounds a lot (for most of us). But $1,000 is less then 4R. It means you are only 3 losers from being back to ~ break even and 4 from being at a loss.

With day trading, you need to capture higher R multiples and maintain a decent win ratio. In a nut shell though, successful retail trading is basically about taking directional risk at opportune times more skillfully then the aggregate market as a whole and finding some ways to capture at least some higher R trades.

This is just one idea. Note to self, I might disagree with this in the future.

Thanks for answering my question, even it cannot fulfil what I want to know. Just like what I mention as the example above, Let's say the current value of crude oil is $50, retail trader go long until the price to $55 to close the trade. In other hand, a petrol company go short at $50 and close the trade at $55. Doesn't matter whether the petrol company is going to win or lose. The company will convert the cost of crude oil to the customer who need to drive. Therefore, the final bill payer (driver) need to pay 10%. Therefore, we always can win in this zero/negative sum. There always get someone who lose in order to make us win.

I can spot out who is the final bill payer for commodity, forex and government bond futures. However, I can't spot out there is any consistent long term bill payer to make us to win in long term on stock index futures. Who else is willing to pay for our winning in long term at stock index futures? Like what you say HFT or hedge fund. What is their strategy to make them willing to lose consistently to make us profit consistently? There is always get someone to cover our profit by their loss in short term. But who else is willing to make retail traders take profit consistently. Especially stock index futures is cash settlement, not goods/product settlement basis, which mean there is always someone who lose their cash in order to make someone's win.

I can't think of any reason that a professional HFT/hedge fund that is willing to give up their profit consistently to make us win consistently. Even the purpose of trading in stock index futures is for hedging. I hope you or someone can sort out my inquiry about this, thx.

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  #5 (permalink)
 
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 wldman 
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get involved in this discussion, but the member perhaps most adept to have a cogent and reliable experience is @artemiso He may chime in as an experienced professional HFT guy or as a math guy.

Wldman would simply say wrong mountain, wrong path.

-Dan

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  #6 (permalink)
 artemiso 
New York, NY
 
Experience: Beginner
Platform: Vanguard 401k
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Thanks @wldman, it can only go downhill from here now that you've hyped my background.

I don't fully follow the question but if I understand you correctly, you're asking who drives the prices on ES and among those, who are the ones that are willing to pay a premium/loss on their trading to intraday speculators.

ES is driven massively by hedgers. There's multiple folks who are holding billions in notional exposure overnight. These include the same organizations that you described - pensions, large asset managers and mutual funds. These are the ones who are willing to pay 20 ticks in instantaneous slippage in a single trade or don't really care about the execution prices of their individual trades so long as they meet other portfolio objectives or have a particular position by the end of day. There's fewer hedgers in the physical commodities field because physical commodities is more consolidated and concentrated than the paper trading industry, and positions and physical inventories are held for much longer.

It comes with these massive inefficiencies that the aggregate profits that speculative firms make on ES are larger than most other futures contracts I know of. However at the same time, the larger the opportunity the more competitive and efficient the market; the firms that I know are dominating ES are generally more sophisticated than the ones I know say, trading CL.

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 wldman 
Chicago Illinois USA
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as a hedger of mere millions of notional value I try to get the best price that I can each day to be somewhat delta neutral overnight. I still strive to make money on the hedge side because as an investor now I very rarely sell long stock. So I operate as the original hedge funds did... short the future as a way to protect stored value when the market is closed.

What I meant by wrong path wrong mountain is subjective and guided by my own hallucination, but who cares if it is a zero sum game or not. I do not believe that it is, but I guess it depends on the construct of zero sum. I try to find and focus on anything I can see, that can be reproduced and most importantly exploited to add money to my account. I do not care whose account or what my trade does for the contra party...only that I cant get my hole opened while I'm in the yard having a cigar around the fire. If I can make an extra bag of cash being wisely hedged I'll do that trade till my balls fall off. If I'm part of the backstop that pays the final bill (almost never happens) I will be happy to pay a few ticks to save a bag of handles on the basket.

So, though I did not want to get involved, there it is. If your concern is who holds the bag on a zero sum game, please trade ES between 720am and noon CST.

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 LittleFinger 
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tpredictor View Post
Hello,
The real source of retail edge comes from ability to take directional risk. You see this is why the market is so predictable (at times) because other participants refuse to trade directional risk. The uncertainty is why it is fair. Most hedge funds will not seek to trade outright edge. Many HFT firms will not trade against you because it is becomes a statistical/empirical edge-- statistical edges are not as good as fundamental, mathematical, and theoretically proven edges. Nobody wants a statistical edge! That is nobody who has access to structural, mathematical, etc. edges want empirical edges. Obviously, the majority of all traders only have access to statistical sort of edges-- so that's the best we have.

This is an excellent point. I'd say this is why a trader can crush it on a day like we had today, but then get those gains ground away in the chop if the news slows down and economic conditions stabilize. We have to pick our battles carefully.

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  #9 (permalink)
 artemiso 
New York, NY
 
Experience: Beginner
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Quoting 
Many HFT firms will not trade against you because it is becomes a statistical/empirical edge-- statistical edges are not as good as fundamental, mathematical, and theoretically proven edges. Nobody wants a statistical edge!

Agreed with @tpredictor here. People are always willing to take a discount to avoid uncertainty. Given 100% of making $100 risk-free vs 50% chance of making $300 and 50% chance of losing $100, I guarantee you most people prefer the former though the expectation values are the same. Many HFT firms will rather book a small profit and hedge out than hold risk overnight or to expiration even if the latter has higher expected profit.

A more practical consideration is that many HFT firms have inventory constraints and simply won't hold more than $x in notional if it moves against them hard enough, and will take a loss to get out. This is in fact the basis of some strategies that these firms use to trade against one another.

Now of course we all complain that the field has become very competitive... more and more we're seeing "pure" arbitrage firms move towards "statistical" arbitrage, low margin trades become high margin trades, large edge trades become small edge trades, short holding periods become long holding periods, as firms take more risk to outcompete others. These market forces are more effective than any regulation in suppressing the profits of HFT firms on a whole... For example, I know to this extent that the 4th best trading firm in a particular exchange is giving up and trying to merge with the 3rd best trading firm in another exchange now, simply because the best 2 firms are just a little better than the 4th. Market making is a winner-takes-nearly-all business. So the next time you hear the SEC or an exchange like IEX push some regulatory agenda, realize that a HFT firm is not really that much scarier than a retail click trader, we all have challenges from competition.

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  #10 (permalink)
 i9506353 
Macau, China
 
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Thx for everyone answer my question, can I understand the fund hedge it like this way. Let's say a Tech company focused mutual fund have a portfolio on holding various of Tech company's stock. The Nasdaq index performance grow up 10% annually. The mutual fund expect to grow up 15% annually.

However, if Nasdaq is going to drop 3% from 10% annual growth due to the volatility/bear market which given Nasdaq only have 7% annual growth. At the same time, the mutual fund will more likely to drop 10% from 14% annual growth after the valuation model if hedging strategy doesn't applied, which only give the fund to have 4% annual return. If the fund is willing to sacrifice the 3% to go short to hedge the Nasdaq futures, then the fund will be more likely to keep it at 7% annual return if bear market is occured. The mutual fund will still have 11% annual return after the fund use 3% to hedge the risk.

Therefore, the mutual fund manger is happy to satisfy the investor whether it is bear or bull market, since the fund will either equal the performance of Nasdaq index during bear market, or outperform the Nasdaq index 1% more during the bull market. I am not sure whether I am correct or not, this is just a guess. Do anyone kindly provide me some more example that hedging/other factor that can give us the consistent edge in stock index futures?

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Last Updated on June 6, 2019


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