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.

4 Responses to The Stock Market Is Not a Zero Sum Game

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James

November 8th, 2011 at 11:20 pm

This argument is utterly feeble, as must be the mind formulating it. Please tell me you don’t trade other peoples money.

The market produces nothing, so it can only be zero sum, with very negligible exceptions, such as dividends and, much more significantly broker fees. So it actually worse than zero sum.

The market reports the illusion of value. But at the end of the day, every trade simply moves money from one person to another.

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Todd

December 6th, 2011 at 1:17 am

I’m wondering, with this in mind, if the market as a whole is not a zero sum game. Maybe in your situation that part of the market was nonzero, but the money you see “vanish” into air is equal to the money generated as a whole. And when we see rises in markets over long term, they must only be balanced out by a recession of some kind, all averaging zero.

Maybe it’s the case that there is no advantage to the market accept to perpetuate an otherwise stagnant market, in order to see advances in society, rather than gaining or losing wealth.

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Fadi El-Eter

December 6th, 2011 at 7:59 am

Hi Todd,

A zero sum game means when someone makes money another will lose money instantly. Forex is a zero sum game, the stock market isn’t. Forex doesn’t produce anything. The stock market does.

The stock produces dividends, shares repurchases, etc…

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Schnulli

January 21st, 2012 at 7:07 pm

Fadi El-Eter: I think you are close. It’s not the market that produces something – it is the company you are investing in. If they find a way to make things more efficient, they will be able to sell more of their stuff at a better margin, making the company more profitable. This will create value for their customers and also for the owners of the company – meaning to some extent the share holder.

A share is (or should be) a representation of a fraction of the company.

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