April 28, 2011 | In: Opinion
The Stock Market Is Not a Zero Sum Game
I was talking to a fellow stock trader a couple of days ago, and we were discussing stocks, and how fast you can make money if you don’t have these two stock trading sins: fear and greed (I will discuss them another time). Anyway, during the conversation, he said something that made me think, he said that when you make money on the stock market, you just take money from one or more investors who just lost money on the same stock, effectively saying that the stock market is a zero same game. A zero sum game means that when someone loses an amount of money, another makes that same amount of money. A real world example of a zero sum game is the forex market. Anytime you make money on the forex market someone loses money, and vice versa, that’s why I feel that the forex market is more like gambling.
However, can we really consider that the stock market is a zero sum game? Let’s say you buy 1,000 stocks of RIG at the current price of $71.62. This means that you have to pay $71,620 for these stocks (excluding commission fees, of course). Now if the stock goes up to $80 in a week, then you will net $8,380. But where is that money coming from? Is it coming from an investor who bought the stock at $78, that doesn’t make sense. Both of you are making money when the stock goes up. A more logical explanation would be to think about those shorting the stock, but what is the percentage of those buying short versus those who are long on the stock. In the case of RIG, it is 1.4%, not enough at all to make up the winnings of the remaining 98.6%. So where is the money coming from? The money is coming from the increased value of the company because of its great earnings, its sunny forecasts for the next quarter, of just because of investor’s speculation. A stock can be viewed as a commodity which price is directly tied to the performance of its company, and, the more performing the company is, the more demand there is on that stock, and the higher the stock will go. So you’re really not “stealing” money from a fellow investor when you make money on a stock, you’re just rewarded because you believed in the company and you invested money in it, and now that investment is generating money. Also, when you lose money on the stock, it doesn’t mean that someone, somewhere, will take your money because he bet against the stock. In most case, when you lose money on a stock, the money vanishes in thin air.
Bottom line is, the stock market is not a zero sum game, which means that us, stock traders, are not making money by sucking the blood of each other.