Comment by thibautx | Hacker News Reader

Comment by thibautx | Hacker News Reader

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To think of finance (or more specifically, trading/investing) as well as financial products/derivatives as a zero-sum game is pretty naive.

A simple example to illustrate my point:

Let's say we have a corn farmer whose crops will come in 4 months. He can buy (or sell) futures contracts/options contracts to guarantee that he can sell his corn for today's market price, in case the price of corn goes down. If the price of corn is up in those 4 months, he can let the contract expire worthless. If the price goes up, he loses the $ he paid for the option contract and some trader (whose job it is to take the other side of the position and manage that risk) profits. But, he is happy to have that insurance despite losing money on that "trade". Financial services extend far outside of the financial sector and benefits people broadly.

Though for each individual trade, it might seem like a zero-sum game, the competition between investors and traders allows for efficient capital allocation and risk management outside of the financial sector. Without financial services, everyone would be exposed to unmanageable risk and volatility which is inherently bad for capitalism.

The reality is that in any futures market 99% of the trading is done by speculators and algorithms. The farmer in your example doesn't normally have the time to keep up with everything going on in the market and will probably end up being ripped off by fees and expensive derivative products marketed to them by unscrupulous brokers.

The interesting thing is that speculators are an essential part of the functioning of financial markets.

A futures contract is essentially an apportionment of risk. When a farmer and a speculator write a futures contract, the farmer is selling the risk that the price of corn will be lower than is profitable, in exchange for a guaranteed profit that is likely to be less than the true expected value of the corn harvest (hence, "fees and expensive derivative products").

If there's a bumper crop of corn and the true market price is much lower than expected, then the person who is wiped out is the speculator, not the farmer. It's much better for society for commodity traders who invested in corn futures to go bankrupt than for all of its farmers to go bankrupt, because farmers have specialized knowledge that is necessary for the future production of corn. In exchange for taking on this risk, they get a profit, which they may choose to invest elsewhere to hedge the risk.

It's basically the inverse of insurance. The farmer may also choose to take out an insurance contract that says "In the event of bad weather that causes my harvest to fail, the insurance company will pay me $X, enough for me to make good my futures contract with the commodity trader and have enough profit that I stay in business next year." As a result, he is completely insulated from events outside of his control, and can focus on what he does best, farming.

Now, I probably agree that there are (or were, pre-2008) too many people in the financial markets, and that we got some chaotic behavior that had to be bailed out by the taxpayers. I also personally chose not to go into the industry - I started my career in financial software, but decided I liked making things more than underwriting other people making things. But it's worth understanding the financial industry's social purpose before condemning it.

"The time to buy is when there's blood in the streets". Speculators often function as the buyer of last resort - the only buyer when everyone else is a seller. That is very a useful role.

>The farmer in your example doesn't normally have the time to keep up with everything going on in the market

That is really the beauty of it though. The market, through speculators and algorithms come up with a risk adjusted price, and the only decision the farmer needs to make is to accept or reject the deal.

How much of Wall Street's turnover serves corn farmers?

Who does Wall Street's turnover serve?

Nobody is saying it works perfectly, but finding a good risk adjusted price is the point.

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