Zero Sum Theory.

trendlover · Mar 10, 2010

Quote from Bolimomo:

I think some of us may have missed the definition of "zero sum" according to the game theory, which was the point of the original post.

Excerpt from wiki:

In game theory and economic theory, zero-sum describes a situation in which a participant's gain or loss is exactly balanced by the losses or gains of the other participant(s). If the total gains of the participants are added up, and the total losses are subtracted, they will sum to zero.

Basically it is saying the pot only came from the chips brought by the players.

For the purpose of the game: you "lose" your money when you exchange your money for stock. Whatever that $x dollar amount it is. The party who sold the stock to you gain that $x amount. Until you liquidate your holding, then you calculate your realized gain (or may be loss) based on your purchase price.

In the case where a stock's price goes up and up and up: it is still a zero sum because the new stock prices are paid by the new players who bring in additional money to the pot. It is still a zero sum game - only that the pot gets bigger over time. Those who gain - their gain money come from the players who come to the game late. That's what it meant by zero sum. The stock price of X may well go to $10000 per share. If sold, the money needs to come from the new players who bring in new money.

(Now how does this universe gets more and more money over time? That's a different question.)

But I said upthread the equity market is not exactly zero sum (just slightly off) because of the reasons stated earlier:

1) Companies paying out dividends. These additional money did not come from new players. They come from the companies' earnings now distributed to the players.

2) The ever-increasing numbers of players who claim some of the pot money but did not bring money to the table. Incentive stock options granted by the companies to their employees.

Plus other activities (such as companies using their stocks as currencies to buy out other companies, etc.).
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This make alot of sense to me.

MK90210 · Mar 10, 2010

Bolimomo,

the awareness that a simple transaction involves a buyer and a seller and thus a price which is paid and received is great (Honour goes to economics esp. "Institutional Economics" and esp. "Game Theory", bravissimo! Truly.). Of course both sums (money paid by buyer and thus money received by seller) are equally. Great. But that does not sound new and does not lead any further.

Anyway, in my example one can see that there is a win for every paricipant except C (the buyer for $20, who has no loss) which sum up to $200. This is the result of the transaction (the trade) and shown with simple balance sheet mechanics.

MK

EdgeHunter · Mar 10, 2010

Quote from jagadish:

Trading = Zero Sum
Investing != Zero Sum
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Life is A Zero Sum Game... You Leave With Nothing...

Scataphagos · Mar 10, 2010

Quote from EdgeHunter:

Life is A Zero Sum Game... You Leave With Nothing...
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You mean, "you come into the world with no hair, no teeth, and wearing diapers..... and exit the same way?"

EdgeHunter · Mar 10, 2010

Quote from Scataphagos:

You mean, "you come into the world with no hair, no teeth, and wearing diapers..... and exit the same way?"
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Buzzed · Mar 10, 2010

Quote from Bolimomo:

I think some of us may have missed the definition of "zero sum" according to the game theory, which was the point of the original post.

Excerpt from wiki:

In game theory and economic theory, zero-sum describes a situation in which a participant's gain or loss is exactly balanced by the losses or gains of the other participant(s). If the total gains of the participants are added up, and the total losses are subtracted, they will sum to zero.

Basically it is saying the pot only came from the chips brought by the players.

For the purpose of the game: you "lose" your money when you exchange your money for stock. Whatever that $x dollar amount it is. The party who sold the stock to you gain that $x amount. Until you liquidate your holding, then you calculate your realized gain (or may be loss) based on your purchase price.

In the case where a stock's price goes up and up and up: it is still a zero sum because the new stock prices are paid by the new players who bring in additional money to the pot. It is still a zero sum game - only that the pot gets bigger over time. Those who gain - their gain money come from the players who come to the game late. That's what it meant by zero sum. The stock price of X may well go to $10000 per share. If sold, the money needs to come from the new players who bring in new money.

(Now how does this universe gets more and more money over time? That's a different question.)

But I said upthread the equity market is not exactly zero sum (just slightly off) because of the reasons stated earlier:

1) Companies paying out dividends. These additional money did not come from new players. They come from the companies' earnings now distributed to the players.

2) The ever-increasing numbers of players who claim some of the pot money but did not bring money to the table. Incentive stock options granted by the companies to their employees.

Plus other activities (such as companies using their stocks as currencies to buy out other companies, etc.).
More...

To expand on your definition of zero sum, i would have to disagree that it is not zero sum. Why? The IPO comes from the corporation. Dividends come from the corporation. But where does the corporation come from? Lenders, clients, and consumers.

Therefore by your definition zero sum is the entire world economy.

But then you take into account the money supply. Where does it come from? Now is the economy still zero sum? Maybe it is since money only represents wealth and is not actual wealth itself. But what really is wealth?

dealmaker · Mar 10, 2010

Trading is not a zero sum game, its a minus sum game. Zero sum assumes 50/50, which does not take into consideration rent, commissions, pass through fees, margin costs etc.. Which's why rate of success is so low.

CoolTraderDude · Mar 10, 2010

Quote from MK90210:

Dear Bill and friends,

please read my post before replying.

Imagine the following: Person A, B and C. Mr A and Mrs B are the lucky ones owning ten stocks of company X each. Yesterday stock of X was priced at $10. So the equity (this is assets minus liabilities, which are assumed with zero here) of Mr A is $100 (ten times the share price) and the equity or net assets of Mrs B is worth $100, too.

Early this morning Mr C came up with the idea of buying one lousy share of company X at any price below $20 (e.g. "BUY 1 X LIMIT 20"). As Mrs. B is the only one willing to sell shares of X and she is demanding a price of exactly $20, the transaction takes place at the named size (one piece) and price ($20) resulting in the fact that every owner of X shares activates his shares in his balance sheet as an asset with exactly this price of $20. So we got the following net asset values:

A: 10 * $20 = $200
B: 9 * 20 = $180
C: 1 * 20 = $20
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sum = $400

This is obviously much more than what we had before the transaction took place (sum = $200). So, if the sum is another than the sum the period before, how can you name it a zero-sum-game? So, pleeeease: Let me know.

MK
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Hello MK90210!

I actually agree with you! What MK is describing is actually a "thin" market where all of the "offers" were pulled to the $20 level. As such, wealth was created for those that held "long". It is only if there were an equal number of "shorts" during this period that the scenario would be zero sum. The sale taking place at $20 happens to be a straight sale, it is not a "short". The owner actually owns the stock and is booking a profit.

Examples from real life... Well trillions were lost during the latest financial crisis so where is the transfer of wealth? Who took the other side of the housing crash? Where did that money go? Any trillionaires out there?

Buzzed · Mar 10, 2010

Quote from CoolTraderDude:

Examples from real life... Well trillions were lost during the latest financial crisis so where is the transfer of wealth? Who took the other side of the housing crash? Where did that money go? Any trillionaires out there?
More...

All that money went to the people who flipped houses before the crash and to the lenders who re-sold the mortages before the crash.

No money was actually lost during the crash itself, it was merely a price adjustment.

MK90210 · Mar 10, 2010

Hey Dude,

> Examples from real life... Well trillions were lost during the latest financial crisis so where is the transfer of wealth? Who took the other side of the housing crash? Where did that money go? Any trillionaires out there?

Yes Sir! Mille Gracie. Very good. Thank you for that.

Just one little point: My example is simplified, of course (only three participants etc) but it has NOT to be a thin market but it could be the most liquid stock in the world. Only difference: Most of the time it will be several (thousands) of transactions and not only one leading to a price increase of 100% and thus to an asset value "creation" (e.g. the searched sum in the game). The principle is still the same and works for all assets anywhere and any time (house market, precious metals, you name it).

Have a nice day.

MK