Debunking Myths - Is trading really a Zero Sum game

Discussion in 'Trading' started by Joab, Jul 12, 2008.

  1. Joab


    Let's tackle some one at a time.

    A. Commissions, I personally average $200 per day on 40,000 shares including all costs.

    Times 5 days per week = $1000 x 4 weeks = $4000 per month.

    How much per day / week / month do you think EVERYONE pays net net. ???

    So is trading really a Zero Sum game ?

    How much profit must be generated to just cover this ?
  2. Zero-sum is a game theory term that describes a system where sum of all participant's gains and losses is zero.

    If every contract in the market is closed before expiration, then it is a zero-sum situation. Minus commissions.

    But the main purpose of the market is to provide a place where stuff can be bought and sold, where supply and demand meet. If you don't agree with this, then the markets lose the meaning, you might as well be trading worthless empty cans contracts. So a real seller agrees to deliver the stuff, thus he doesn't close the trade before expiration. A real buyer takes the delivery, he does not close the trade before expiration too. These two subjects, contrary to traders (speculators and arbitrageurs) don't care about profiting from price movements. Does that make markets non zero-sum? I believe so.

    There may be disagreement about indices. But the same people usually agree that stocks are not zero-sum, since you are buying real property with them (i.e. companies). What is a stock index? It's sort of a basket of stocks, or mutual fund. x% of this stock, y% of that stock, etc. So if you agree that stocks are non zero-sum, then indices are non zero-sum too.
  3. Stock trading FX etc are not zero sum games.

    Theses activities are quite similar to gamlbing [incidentally this is where I got my initial captal from to strat investing...].

    Consider a game of poker house takes 1% of the pot [commission, spreads etc]. You would thik this would be a zero sum game less the 1%. If all the contestants are playing with the aim of making money it would be, but consider...

    To make it postiive sum you need a group of players who are don't mind losing money who are happy to keep feeding the better players. Fortunately for pro poker players [and traders] these do exist.

    There will be a variety of motivations for the players.

    1. Some will be doing it as entertainment to get out of the house and spend time with friends and will keep coming back for these reasons even though they consistently lose.

    2. Some will keep coming despite losing becasue they believe all they have to do is find the winning stragey or hoy grail of poker.

    3. Some willl be playing with the hope of learning how to be a good player and make profits in the future. They look at their losses as an investment or education cost. There is a gignatic industry bult up around teaching people how to becomes better poker players.

    So many contestants are happy to pay to play even though if they were only focussed on winning they would give up [a lot of them do but there is always a steady stream of newbies].

    These are called [technically] external benefits ie the contestants primary reason for trading is not to make money by trading.

    Now consider some of the financial market particiapnts:
    Stocks - Mutual funds - derive their primary source of income as fees from funds under management.
    F/X - International trade - primary benfit is exchange of goods and services between countries.
    Futures market - hedging of price and supply risk buyers and sellers

    My 2c is take a leaf from the pros, keep your losses small and be happy to take small consistent profits that build up over time. If you are after the holy grail or that elusive big win you will continue to provide a decent living for someone else.


  4. As already pointed out, but simply said.... Trading is not zero sum because there are those people called value investors that also play in the market.
  5. Only contract markets (futures and options and the like) are zero sum games.
  6. Joab


    Some interesting points but I did not wish to get caught up in the semantics too much.

    At the end of the day does one participant have more money then the rest of the others OR does all the commissions paid net out to make it equal.

    This is the real question.
  7. I would argue that in the long run even trading stocks is zero sum (excluding commissions and fees, of course). However, most players have short-enough term objectives that it really doesn't matter.

    Yes, of course I understand how "everybody can profit during a stock's rise, so stocks are not zero sum"...
  8. nathanos


    Trading is zero sum. As per a rebuttal to an answer in a similar conversation I had on yahoo answers, someone posted:

    "The stock market is NOT a zero sum game. If it was, there would be no long term investors.

    IPO: Jim buys at $55
    Jim sells to Tom at $60
    Tom sells to Bill at $70
    Bill is holding stock, which has appreciated to $80

    Who is losing money?"

    The answer is Bill is losing money, he only has stock, and since stock is NOT money he is down $70. If we imagine the market only consists of these three people and there are no new market participants or influx of new money, it is easy to see how Bill loses. Also, if Jim and Tom refuse to buy, who says his stock is worth $80? The total amount of money does not change unless existing investors invest more, or there are new investors. In real life there are dividends of course, but for the theory of the game we will ignore them (which are surely dwarfed by commissions). Moreover, the sneaky government has it's hands in our 'closed' game by sponsoring inflation, further siphoning value from the very money with which we play our private game.
  9. Trading isn't a zero sum game. On Wikipedia they give the example of a slice of pie as an analogy for a zero sum game. If you take a bigger piece, then everyone else must have a smaller piece. That's zero sum.

    Now consider company ABC. They have 100 million share outstanding and are at $10/share for a total market cap of $1 bil. If you're holding 100 shares of ABC and it goes up to $11/share tomorrow, you didn't make money by taking a bigger piece of the pie. The shares you own (slice) are the same today and tomorrow. You made money because the whole pie got bigger (the market cap went up by 10%). Since the value of everyone's ABC holding went up in the pie expansion without any corresponding losers, the game cannot be zero sum.
  10. nathanos


    All I'm saying is the process of trading is zero sum, e.g. there is no value created in trading itself. The only value created is by those managing the companies the market trades and their corresponding profits, but all of that is outside the realm of the stock exchanges. The process of flipping paper back and forth between each other itself is zero sum.

    If you think about the most basic scenario, imagine we both have $100 and 1 share of stock each. We can trade back and forth back all day but neither can actually gain anything. We could argue the correct price of this paper all day based on underlying factors, but we'll always have $200 total. The only way we could make money is if someone else joined our market and purchased our stocks. This is all the stock market is but on a larger scale. For a group of traders with a given amount of initial capital, the ONLY way they all can come out on top is if there are new buyers.

    The market cap has nothing to do with the size of the pie, it's the money that matters. One person buying one share for an extra dollar does not somehow increasing the pie by $100 million. Stock is nothing if it cannot be converted to cash. People get confused by thinking they 'made money' when the last traded price of the stock they own is higher than when they bought it. You don't make money until you sell.

    And from a monetary/philosophical viewpoint, money is no more valuable than securities, it's just paper. Only once you covert that money into ownership of something real, and have a system to enforce your property rights to own it, do you have something of value.
    #10     Jul 14, 2008