Game Theory

Forex game theory

This page seeks to find some kind of foundational solution to explain what takes place in currency trading; the best explanation is that forex trading is a game. A game is a form of competitive activity and economists have spent their time studying this subject far too much! So much so that studying games is now a whole area of study in itself called game theory. Anybody who plays games will realise that there are different kinds of games that involve different philosophical bases. We shall first look at the kind of game played in investing and then we shall focus on forex trading.

1. Investing

We have already briefly touched upon investing when investigating the ideas of Burton Malkiel. Investing in shares/property and many other forms of assets can be called a game because you are competing with other people to get the best value and return from your investment. This kind of game is called non zero sum and this is because in competing with others, nobody has to actually lose the game. Even though bubbles occur in the economic cycle, the general rule over a long period of time is that the value of assets increase and as a consequence everybody can theoretically win.

2. Speculation

Speculation appears to be a far more complicated game because when one person ‘wins’ another ‘loses’. As a consequence, it is a far purer form of a game than investing and is called zero sum. One has to distinguish though between the basic concept and the actual event. The game is far harder than playing against another opponent because the spread stands against you in every trade. That being said, a speculator has to see the forex game from the zero sum perspective. Speculation can be compared to playing chess, although the former is even harder as shall be demonstrated:

In the forex traders’ world the graph is the chessboard. Unlike chess, the speculator has to discover the chess pieces and how they move with very little help from others. However with a bit of study, the rules of the game can be learnt. One problem is that many people, having discovered the rules of the game, then run in and immediately play forgetting one other principle… you are playing to win which in our context is earning money. To actually win in speculation one has to do what every professional chess player does, one has to also learn the complex strategies that the other players know, learning how to put them together to get a successful result. To make matters worse,  currency trading can be compared with someone taking one of your chess pieces off of the board before the game has even started, due to the spread. The result is that you have to be a very good player to win.

But why would anybody want to play such a hard game if one can simply earn money in a non zero sum game like investing? The answer is that even though the forex game is very difficult, yet the profits can be made quicker, up to a level… the level being the maximum money that the currency trading companies permit you to use during speculation. However when we get into really big money (millions) then investment becomes more profitable.

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