The Charge of the Light Brigade is a poem by Alfred Tennyson inspired by a tragic true event. It recounts how a significant number of British cavalry soldiers charged toward the Russian lines during the Battle of Balaclava in 1854, resulting in their slaughter. This ill-fated assault stemmed from a misunderstood command.
Similarly, a recent SEBI report on Futures and Options (F&O) trading sheds light on a comparable situation in the stock exchanges. The Indian Retail Brigade seems to rush into F&O trading without questioning the misleading narratives that promise easy wealth or assessing the likelihood of success in this zero-sum game. Consequently, the end result has been the transfer of hard-earned money from individual traders to the accounts of sophisticated domestic and foreign traders.
Down the Drain
An anonymous author once said, “Nobody can save a man determined to grow rich suddenly.”
One of the most striking statistics from the report is that between FY22 and FY24, 1.13 crore individual traders collectively lost ₹1.81 lakh crore in F&O trading. This study, which analyzed data from 15 brokers representing 90 percent of individual traders in FY24, reveals that a staggering 93 percent of those who traded in this segment incurred losses. Each losing trade in F&O has a counterparty who gains significantly, with foreign portfolio investors (FPIs) and proprietary traders largely benefiting from this scenario. This has led to a considerable wealth transfer, amounting to about $22 billion, from the accounts of mainly middle-class Indian retail traders to a select few sophisticated foreign institutional investment firms and proprietary trading shops, alongside brokerages that profit from transaction fees. This situation exemplifies the rich getting richer while the poor get poorer, not because of any systemic corruption or government policies, but due to retail traders charging unprepared into the F&O slaughterhouse.
Why Such a Discrepancy?
The reason for this imbalance is that earning profits in a zero-sum game is inherently challenging.
A zero-sum game is defined as one in which wealth is neither created nor destroyed. In this context, one trader’s gain equates to another’s loss. Consequently, zero-sum games fundamentally involve wealth transfers. For example, if two traders, A and B, take opposing positions in an F&O trade—one buying a put or call option while the other sells it, or one taking a long futures position while the other shorts it—only three outcomes are possible: A loses while B gains, A gains while B loses, or both A and B lose, with only the brokerage benefiting from the transaction costs. Notably, both traders cannot win simultaneously.
This scenario is akin to a cricket final, where only one team can emerge victorious, and ties are impossible. However, unlike cricket matches, the odds in F&O trading heavily favor one side. When luck is taken out of the equation, the trader who is better skilled, more prepared, and equipped is the one who ultimately prevails. Even if we assume retail traders are as capable as those in sophisticated foreign and domestic trading firms and adequately prepare, they cannot compete with these institutional traders regarding access to information and the ability to act swiftly. Institutions possess access to a wealth of information—often at a premium and unaffordable to retail traders—including institutional sell-side research, Bloomberg terminals, and algorithms for testing and executing trading strategies based on technical, fundamental, or quantitative analyses. They also have the financial resources to employ analysts who gather and process vital information for making informed decisions. Additionally, institutional traders often gain access to direct meetings with company management or attend conferences. While luck also plays a role, institutional firms tend to manage risks effectively, thus mitigating the impact of bad luck and reducing ingrained biases.
While individual traders can indeed win—especially if they are disciplined and better equipped—their chances are slim against these odds. This may explain why, during FY22-24, only seven out of every 100 traders profited from F&O trading. Even among these seven, only one managed to earn profits exceeding ₹1 lakh after accounting for transaction costs.
In essence, the Indian F&O market has become a significant mechanism for wealth transfer.
Wealth Transfer vs. Wealth Creation
Isn’t the entire market a mechanism for wealth transfer? Not necessarily. If you are a long-term investor, you engage in a wealth creation process. While the stock market may not perfectly align with GDP growth annually, over the long term, it generally tracks that growth. As GDP rises, stock values typically increase, resulting in wealth creation. Your likelihood of making money is significantly higher when you participate in the wealth creation process rather than the wealth transfer process. For instance, if you purchased the Sensex at the peak of the boom in 2007, your wealth would have compounded at a respectable rate of 11 percent (12.5 percent total returns, including reinvested dividends) to date.
Given that markets are currently at all-time highs, anyone could have capitalized on wealth creation as long as they were willing to wait and did not impose time constraints on their investments. This is not the case in F&O trading, where traders must act within fixed contract expiration periods.
Why Do Traders Persist Despite Low Odds?
One revealing statistic from the study indicates that 75 percent of loss-making traders continued to engage in F&O trading despite suffering losses in the previous two years. This behavior exemplifies the Gambler’s Fallacy, the belief that if a particular outcome has occurred repeatedly, it is likely to change in the future. A common illustration of this concept is the coin toss.
Every time a coin is flipped, the odds of it landing on heads remain at 50 percent. If a coin is tossed four times and results in heads each time, the gambler’s fallacy leads one to assume the next toss will yield tails since it has already landed heads consecutively. This thinking is flawed, as each toss is independent, and the probability remains constant.
The same applies to every trade you execute. Each trade is an independent event. Even if you experience losses in 100 consecutive F&O trades, your odds of winning the 101st trade do not improve unless you have significantly enhanced your understanding of the F&O market and improved your skills compared to your counterparts. Therefore, believing that you can learn from your past mistakes to increase your chances in the next trade may not hold true, as your counterparts are also continuously adapting and improving.
Ultimately, success in trading will depend on who can learn and adapt more effectively.
If you have incurred losses in multiple F&O trades and believe you have gained insights from these experiences, you should reconsider how sound your initial judgment was when you first entered the F&O market with the belief that you could achieve profitability.
