A zero sum game is where the profit made by ‘winners’ is equal to the loss made by ‘losers’, hence making it an equal trade off of zero. Many people believe that the stock market is an example of a zero sum game, but they are wrong.
The stock market as a whole is not a zero sum game. Because it is based on company performance, the underlying assets increase or decrease depending on the value of the company. However some aspects of the market are considered zero sum games, such as options or futures trading.
People often think of the stock market as a zero sum game because it has winners and losers. However when the underlying economy is doing well, there are more winners than losers, but the opposite is not always true when the economy is poorly performing.
Why isn’t the Stock Market a Zero Sum Game?
The main difference between zero sum games and non-zero sum games is the transfer of value. A good example of a zero sum game is tic tac toe, 1 person wins while the other loses. The stock market is a non-zero sum game because of the example below:
- Company ABC Inc issues new shares to be traded on the exchange.
- Investor ‘A’ buys these shares, and the company receives the proceeds.
- Investor ‘A’ sells the ABC shares to Investor ‘B’, Investor ‘A’ receives the proceeds.
- Investor ‘B’ has not made a loss because they still own the value of the shares. Even if the shares decrease in price, until Investor ‘B’ sells the shares to another investor, the loss is not realised.
Economist look to deep into this problem… By saying that Investor ‘B’ buying the shares from Investor ‘A’ is a loss of Investor ‘B’s money is completely wrong, because the investor can hold the shares for as long as the company is trading. So the value is still there, it just might not be as much.
A zero sum game is something like poker. All players bet an equal amount and there is one winner. No extra money is introduced, and no money is taken out.
The stock market always has new money introduced, either by newly issued shares, new investors, or dividend payments. Investments in the stock market help companies generate profit, increasing their value. Sometimes this doesn’t work, but a companies value is never zero.
Options & Futures
Options and futures are the closest thing you will get to a zero sum game within the stock market.
This is because they are a form of ‘spread betting’ which has two people betting on whether a stock will go up or down.
When you invest in an option you enter into a contract with another party, you can either short the market, or long the market. But if you are wrong, your capital is transferred to your competitor. That was a simple explanation of options trading, generally people will bet on the underlying asset to rise or fall a set amount in a specific time frame, but investors can close the contract before the expiration date at a profit.
Even though the investor has made money from that bet, there will be a corresponding loss, and the net result will be the transfer of wealth from one trader to the other, disregarding any brokerage fees, this is a zero sum game.
The Open System
Another reason the stock market is not considered a zero sum game is because it is an open system. There are two players in the stock market… The Investor, and The Corporation.
The corporations issue stock when it suits them, to make the best business decision. When their stock is relatively cost, the company will issue shares to be bought at the higher price, whereas they will retire shares if the stock price is undervalued.
Unfortunately for us, corporations are neutral investors so they issue shares when it suits the businesses needs. But because companies can issue shares basically whenever they want, it puts the investor at a disadvantage because shares that were once worth more, are now worth less, and no one but the company has seen any money.
Zero Sum Games in Day Trading
Day trading can be done of most assets most commonly on:
- Stocks & Shares
- Options & Futures
We’ve already discussed stocks and options trading, and we know options is the closest thing you can get to a zero sum game when investing in corporations.
Forex, commodities, and indices however… They are other forms of spread betting that can be seen as a zero sum game.
Trading these types of assets is complex and requires a lot of training to become successful. Forex and commodities markets are set up so you don’t actually own the underlying asset, you are just betting whether it will rise or fall, but you do not have a time frame with these, you can hold onto a trade for as long as you want, whether it is profitable or not.
Again because you are betting on price movements against other traders who have different opinions, you are involved in a zero sum game.
Forex is one of the only zero sum games with an open system. Banks buy and sell currency, driving the price up and down. Unless you are the owner of the bank, you have no idea whether Barclays will buy more Euros or sell them, so this open system is controlled by the banks instead of corporations.
When it comes to commodities like gold or oil, it is based on supply and demand of that commodity. If new oil is found, the price will drop, whereas if oil is running out, the price will increase. People bet on which way the price will go, and more often than not the win loss ratio is 50/50.
Many day traders sell what are called ‘trading signals’, these are the traders that boast about their 80% win rate. However I would steer clear of them, because in a zero sum game the odds are always 50/50, and an 80% winner can easily become a 60% loser overnight.
There might be ways to analyse a chart technically and look for price indications, but like I said, the price can move two ways, and no one knows which.
Stay Away from Zero Sum Games
The final point I would like to make about zero sum games is that they are a form of gambling.
Options and futures are the safest zero sum games to be involved with because you can base your ideas on a companies performance, which gives some evidence to back your decision.
But when it comes to investing I would stick to the long term investments of solid companies. If you want to invest in a zero sum game, you can go to the casino and sit at a Black Jack table, but when gambling without the proper knowledge or experience, the house always wins.
Casinos like day trading brokers, look for people to invest money in a game so they can take a cut of the profit… No matter which way the trade goes, they always win!