“Theirs not to make reply, Theirs not to reason why, Theirs not to reason why, Theirs but to do and die. Into the valley of Death. Rode the six hundred” - The Charge of the Light Brigade is a poem by Alfred Tennyson based on a grim true story.

It is about how a large number of British Cavalry soldiers charged towards the enemy’s (Russia) den only to get slaughtered in the Battle of Balaclava in 1854. It was a suicidal attack triggered by a misunderstood order!

The SEBI report on Futures and Options (F&O) trading, released last week, reveals something similar playing out on the stock exchanges. The Indian Retail Brigade, which has been charging into F&O, does not seem to question misleading narratives about the easy riches to be had in F&O, or gauge the probability of success or failure in a zero-sum game. The net result has been hard-earned money getting transferred into the accounts of sophisticated domestic and foreign traders.

Down the drain

Nobody can save a man determined to grow rich suddenly – author unknown.

The most compelling statistic from the report is that during FY22-24, 1.13 crore individual traders incurred a combined loss of ₹1.81 lakh crore in F&O trading (study based on data from 15 brokers who accounted for 90 per cent of total individuals in FY24).

Those who lost money represent a staggering 93 per cent of individual traders in this segment. Every loss-making trade in F&O has a counter-party who pockets big gains. In this case, it was FPIs and proprietary traders. This reflects a massive wealth transfer of around $22 billion from the bank accounts of mostly middle-class Indian retail traders to the bank accounts of a very few sophisticated FII pod shops such as Jane Street and Millennium Capital, apart from proprietary traders and brokerages (transaction costs).

The rich getting richer and poor getting poorer, not due to any government policy or corruption in the system, but due to retail traders charging unprepared into the F&O slaughterhouse.

Why is the statistic so lopsided? It’s because making money in a zero-sum game is hard.

Wealth transfer...

A zero-sum game is defined as one in which no wealth is created or destroyed. In such a game, one person’s gain is the other’s loss.

So, zero-sum games ultimately involve wealth transfer. If two traders A and B take opposite positions as counterparties in an F&O trade (one buys put/call option, while the other sells the put/call option, or one takes a long future position and the counterparty sells the future — shorts the future position), then ultimately there are only three outcomes possible – A loses and B gains, or A gains and B loses, or A and B lose and only the house (brokerage) wins from the transaction costs.

Very pertinent to note here that both A and B cannot simultaneously win.

This is like a cricket match final where only one team can win, and no tie is possible. But unlike cricket matches, here the odds are loaded in favour of one side. If you keep luck out of the equation, the one who is more skilled, more prepared and more equipped wins.

In the zero-sum game of F&O, even if we take it for granted that retail traders are as talented as the traders in the sophisticated foreign and domestic pod shops and also prepare well, they just cannot match the pod shops and proprietary traders in terms of access to information and the ability to act swiftly on it.

Institutions have access to a wealth of information — which comes at a premium and unaffordable to retail traders — like institutional sell side research and reports, Bloomberg terminal, algos and software to test and execute trading strategies based on technical/fundamentals/quant.

They also have the financial resources to employ analysts to gather primary and secondary information and process it for making better decisions etc. Institutional traders and analysts also get access to meet company managements directly or in conferences.

This apart, of course, there are factors like luck, but here too the pod shops score better not because randomness loves them, but because they have risk management rules to reduce impact of bad luck and eliminate entrenched biases.

It is not that it is impossible for individual traders to win, as a better-equipped and disciplined individual trader can still win over other individual traders and may be against the pod shops too.

But the chance of winning is extremely low against all these odds. This is perhaps why only seven out of every 100 traders made money from trading in F&O during FY22-24. Even amongst these seven, it is not like the profits were great. Only one out of those seven managed to make a profit exceeding ₹1 lakh after adjusting for transaction costs!

To put it simply, the Indian F&O market has been a massive wealth transfer platform.

...vs wealth creation

Isn’t the whole market a wealth transfer platform? No. If you are a long-term investor, you participate in a wealth creation process. While the stock market may not exactly track GDP growth year by year, in the long term it does.

As GDP grows, stocks grow, and wealth is created. Your chance of making money is significantly higher if you partake in the wealth creation game rather than in the wealth transfer game.

For example, even if you bought the Sensex at the peak of the boom in 2007, your wealth would have compounded at a very decent 11 per cent (12.5 per cent total returns including dividends re-invested) till date.

With markets at all-time highs today, every single person would have had an opportunity to make wealth as long as they played the waiting game and did not constrain their investment with a time horizon. Not so in F&O, where the trader does not have the luxury of time as contracts expire at a certain point in time.

But why do traders persist despite the low odds?

The gambler’s fallacy

One piece of data from the study is that 75 per cent of loss-makers persisted with trading in F&O, despite making losses in the preceding two years.

That is a clear demonstration of the Gambler’s Fallacy. This is a belief that if a certain independent outcome has persisted for a while, then it is likely to change in the future. The most common example to understand this is a coin toss. Every time a coin is tossed, the probability that it will be heads is 50 per cent.

If a coin is tossed four times and all four times it has turned out to be heads, then the gambler’s fallacy tendency is to think that the next toss will result in tails, as it has been four consecutive heads before. But that thinking is wrong, as each toss is independent and each time it is tossed, the probability of the result being heads is 50 per cent and tails 50 per cent.

So is the case with every trade you make. Each trade is independent. Even if you have lost in 100 consecutive F&O trades, your probability of winning the 101st trade will not improve unless you have remarkably transformed to understand the functioning of the F&O market and have become much smarter than your counterparties.

So, to think you have learnt from your mistakes and have a better chance in your next trade may not be entirely correct, as your counterparties are also continuously evolving and trying to get better. Eventually, it will depend on who is the better and quicker learner.

If you have lost money in F&O in multiple trades and believe you have learnt from mistakes and persist, you must ask yourself how right were you when you entered the space first believing you can make money in F&O.

Art of dealing with losses

Prevention is better than cure. To that extent, not needlessly venturing into F&O, or entering with strict stop-loss rules are ways to prevent painful losses. However, if anyone has been caught in the web of F&O and are finding it difficult to deal with the heavy losses, here are a few points to consider.

One, there is no shame in making losses, but maybe there is when it comes to not dealing with it with maturity.

Making money in F&O is much harder than one thinks at the time of entering. But more important, dealing with losses also becomes much easier over time. Not acknowledging this can inure you to larger and larger losses until you are neck-deep in trouble. This is how people end up betting their entire retirement proceeds or take on high leverage to trade. Having hard limits on the capital devoted to F&O and stop-losses can save you from such disaster.

Two, if the losses are traumatising you, it is important to seek help from friends and family or from a professional counsellor. It is imperative to get it addressed and not hide it from friends and family. Do keep in mind the losses associated with F&O experience can result in entrenched biases that can impair your decision-making. This can also hinder you from spotting and capitalising on other good opportunities as and when they show up, like in long-term investing.

Three, one common regret amongst F&O traders who have lost money is not just about money given up, but also the time and effort spent over the years trying to recoup losses or make money. Fret not, efforts and experience hardly go in vain. One just has to give some time for these learnings and experience to help you out at a different time in a different stage in life.

Four, should you persist or let go? Legendary trader Jim Simons once said, ‘Discretion is the better part of valour, but persistence has a lot of value.’ Thus it’s a very hard decision to make, but if one does an unbiased analysis, it is crystal clear the odds of making money are very low. In most of the cases, it is better to show discretion and give up. If you decide to persist, then you must have a few unnegotiable rules – giving up if the next x number of trades are unsuccessful, if you suffer from negative emotions while looking at P&L or are distracted from your core profession due to trading.

Bear in mind the best of intellect, learnings and experience does not guarantee success in trading. Any doubts, check the story of Jesse Livermore.

Five, monetary gains and losses are one thing. But the true winner from F&O trading is the one who has lost money after spending years trying it out, but has the maturity to let go of it. Very few attributes equip a person to be successful in life, as the ability to discern when to let go.

If you have been traumatised by your experience from trading in F&O and want to share your experience, please write to us at blportfolio@thehindu.co.in

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