Zero Sum games

[Lee Shepherd]

For every buyer there is a seller and vice versa, therefore if you sold your contract your friend cannot then sell until he has bought it, short or long.

You sold your contract, someone else bought it. they sell it and so on.

If I short(sell) a contract then someone has to go long(buy it) when I dump it on the markets either before or after depending on what direction of stock is bought. If this does not happen then contract will not fill until price matches a buyer/seller. Hence what market makers do.

I buy a contract at 1000 from an investor who's cashing up his profits as it starts an intraday rise. I sell it at 1020 as I think its topping out. A friend who trades countertrend sells short and happens to get my contract. Back at 1010 he sells.

We all profited. We bathed it the warm goodwill of it all and wished the fourth party good luck in his or her dance with the contract.

 

[intradaybill]

In addition to arabiannights' comment, you're kind of missing the point - you can't just ignore the other traders - it's their losses that make the game zero-sum. Obviously winners can trade amongst themselves a bit, but the money for them to profit has to come from somewhere.

It is amazing fifty2aces that some people cannot digest this simple fact. They cannot understand that in order to profit someone else must lose. They think that value creation generates profits while forgetting that these profits are not realized until someone else buys what they have to sell. No wonder there are so many losers in the trading game.

Bill

 

[arabianights]

It is amazing fifty2aces that some people cannot digest this simple fact. They cannot understand that in order to profit someone else must lose. They think that value creation generates profits while forgetting that these profits are not realized until someone else buys what they have to sell. No wonder there are so many losers in the trading game.

Bill

The point is that you are selectively chosing to count some very selective opportunity cost as a loss so that you can define equities as a zero-sum game for reasons unknown.

 

[Lee Shepherd]

Dont quote me, Quote these inexperienced traders.

Here are some excepts I've got from traders and people alike that obviously dont know what their talking about. Hey, what do they know..I know better than all them put together. I've been trading 2 months now and theres nothing you can teach me about trading.

...winning traders can only profit to the extent that other traders are willing to lose. Traders are willing to lose when they obtain external benefits from trading. The most important external benefits are expected returns from holding risky securities that represent deferred consumption. Hedging and gambling provide other external benefits. Markets would not exist without utilitarian traders. Their trading losses fund the winning traders who make prices efficient and provide liquidity.

Lawrence E. Harris
Chair in Finance, University of Southern California


...as you describe it, it [the market] is, of course, a game in which there are real consequences. When you bet and you win, that's good for you, it's bad for those against whom you have bet. There are always losers in this kind of a game.

Ted Koppel


I write a series for Slate called "Bad Advice," in which I take common but poor investment advice and explain why it's bad. One of my consistent themes is that, in most cases, the more you trade, the worse you do. The logic behind this is that, unlike investing, trading is a zero-sum game: every dollar "won" by one trader must be "lost" by another. (When you throw in transaction costs, moreover, trading becomes a negative-sum game: most traders lose.)

Excluding costs of brokers transactions/spreads, this makes it zero sum.

Henry Blodget - is best known as a former securities analyst who was senior Internet analyst for CIBC Oppenheimer during the dot-com bubble. He was later employed by Merrill Lynch

 

[davidnmfarrell]

Wow this thread is going strong! I think I made these points earlier, but they are clearer below:

"non-zero-sum describes a situation in which the interacting parties' aggregate gains and losses is either less than or more than zero." (Wikipedia)

How are the values of shares derived? What if someone puts in an absurdly high offer that is not yet realised - doesn't the value of the shares rise without anyone exchanging anything?

Next question, what about in a bull market where the whole market is is growing in value? Does the zero-sum claim then imply that the same number of losers/winners exist in both bull and bear markets? Seems unlikely doesn't it?

What I'm leading to is this: prices of shares are not derived from what the last price was paid for the share, rather what the NEXT price paid for the share will be (those listed on the order book of the exchange), this means that there is not necessarily a 1 to 1 correllation with buyers and sellers of share prices.

Investopedia agrees:
"Options and future contracts are examples of zero-sum games (excluding costs). For every person who gains on a contract, there is a counter-party who loses. Gambling is also an example of a zero-sum game. A stock market, however, is not a zero-sum game because wealth can be created in a stock market".

In other words share prices can rise without any exchanges taking place - everyone can win in a bull market and therefore it's not zero-sum.

 

[davidnmfarrell]

"The logic behind this is that, unlike investing, trading is a zero-sum game: every dollar "won" by one trader must be "lost" by another. (When you throw in transaction costs, moreover, trading becomes a negative-sum game: most traders lose.) Excluding costs of brokers transactions/spreads, this makes it zero sum."

The other guys quoted don't call it zero-sum, so lets just focus on this one. Key point is that he really admits more than he should with this line:
"unlike investing..." - as if there is a hard and fast distinction between the two!

Gimme a break!

 

[Lee Shepherd]

Like I said, dont quote me. It's what they said.

The other guys quoted don't call it zero-sum, so lets just focus on this one. Key point is that he really admits more than he should with this line:
"unlike investing..." - as if there is a hard and fast distinction between the two!

Gimme a break!

 

[intradaybill]

In other words share prices can rise without any exchanges taking place - everyone can win in a bull market and therefore it's not zero-sum.

Share prices cannot rise unless transactions take place. it doesn't matter what the offer is if nobody wants to take it.

As such, trading is a zero sum game because all transactions involve buyers and sellers and there is simply no way for some to win without some others losing. It is common sense that the losses of the traders that lose become the profits of the traders that win. Zero-sum game. Other profits, like dividends, are of course there but not part of trading game. These are external benefits to trading.

Investopedia and Wikipedia are unreliable sources. You may as well ignore them. Listen to common sense instead. People get destroyed when not listening to common sense.

Bill

 

[Lee Shepherd]

good point intradaybill,

The only problem we have here is that telling a new trader(and some 'experienced') this game is not zero-sum is like telling the pope there's no heaven. Correct that there are some external factors, ie, dividends from shares come from the profits(money from customers that another company would have lost out on) and is divided between the company owners(shareholders).

It's a scary thing to believe that when you've made a profit, some one else has lost. Usually this is the new traders money and they find the whole concept scary beyond belief, therefore it's better to live in ignorance.

TRADING IS NOT ZERO SUM AND EVERYONE CAN WIN AT THIS GAME OF TRADING.
WHEN I WIN IT'S NOT FROM ANOTHER TRADER LOSING, THE MONEY COMES FROM...ER...MM..WELL IT COMES FROM SOMEWHERE..MAYBE FROM THE HEAVENS..I DONT KNOW..BUT WHAT I DO KNOW IS THAT TRADING IS NOT ZERO SUM AND WHATEVER YOU SAY I WONT LISTEN..

This is my belief and I'm sticking to it.

 

[new_trader]

Wow this thread is going strong! I think I made these points earlier, but they are clearer below:

"non-zero-sum describes a situation in which the interacting parties' aggregate gains and losses is either less than or more than zero." (Wikipedia)

How are the values of shares derived? What if someone puts in an absurdly high offer that is not yet realised - doesn't the value of the shares rise without anyone exchanging anything?

Next question, what about in a bull market where the whole market is is growing in value? Does the zero-sum claim then imply that the same number of losers/winners exist in both bull and bear markets? Seems unlikely doesn't it?

What I'm leading to is this: prices of shares are not derived from what the last price was paid for the share, rather what the NEXT price paid for the share will be (those listed on the order book of the exchange), this means that there is not necessarily a 1 to 1 correllation with buyers and sellers of share prices.

Investopedia agrees:
"Options and future contracts are examples of zero-sum games (excluding costs). For every person who gains on a contract, there is a counter-party who loses. Gambling is also an example of a zero-sum game. A stock market, however, is not a zero-sum game because wealth can be created in a stock market".

In other words share prices can rise without any exchanges taking place - everyone can win in a bull market and therefore it's not zero-sum.

Yes, this is also what I thought.

ZERO SUM:
3 people decide to meet at someones house to play poker and they each bring a stake of £50.00. Therfore, going into the house is a total of £150.00. By the end of the night, 2 players have lost everything and 1 player has won everything. Therefore leaving the house is still a total of £150.00 but it's only in 1 pocket instead of 3.
IN=£150.00
OUT=£150.00


NON-ZERO SUM?)

3 people each decide to buy £50.00 worth of shares in an IPO of Widget PLC which at the time is only selling 50 widgets/week. The following week, demand for widgets skyrockets and they are now selling 150/widgets week. As a result, the balance sheet for Widget PLC looks much better and so the shares double in price. ie/ The people who already own shares do not offer any shares for sale below £100.00.

3 new investors come along and buy all the holdings from the original 3 @£100.

Who has lost money at this point?

 

[Lee Shepherd]

The other widget company and there shareholders. Same as on indices.

 

[new_trader]

The other widget company and there shareholders. Same as on indices.

There is only 1 widget company - Widget PLC

 

[Profitaker]

Options are zero-sum, period. This has been clearly explained on this thread and should not be difficult to grasp.

Stock markets however, are very close to zero-sum and needs a little more thought.....

If Widget Plc went from selling 50 widgets/week to selling 150 then this will be offset by it's competitor(s) selling 100 widgets/week less. If the total market for widgets has increased then this will be offset by a similar value decrease in another market. So in the grand scheme of things where one company and it's investors gain, somebody, somehwere, will lose.

 

[davidnmfarrell]

If Widget Plc went from selling 50 widgets/week to selling 150 then this will be offset by it's competitor(s) selling 100 widgets/week less. If the total market for widgets has increased then this will be offset by a similar value decrease in another market.

This is the crux of it, thanks for focusing the thread on this point.

I am going to disagree of course

I think it's the case that prices paid for goods are not derived from an objective and rational value calculation, but they're simply market prices - which are manifestations of the perceived utility of the goods, by potential buyers and sellers. Therefore, because share prices are derived from perceived utility, they cannot be zero-sum.

Economists in the past have endevoured to establish objective methods for calculating the value of a good, but they have always failed. Marx for example believed the value of a good should be determined by the amount of time and labour that went into producing it.

I think it was Ricardo's theory of Comparitive Advantage which explained that by working together, we can increase wealth through synergies. In other words, by being more efficient we can exact a creation of wealth without an equal negation taking place in another part of the market.

I would agree though, that broadly speaking, the market tends to produce winners and losers.

 

[davidnmfarrell]

I may have recommended the wrong post.. see if you can guess which one

 

[Lee Shepherd]

Profit taker has hit the nail on the head, thats pretty much the short and tall of it and how the markets work. Of course they'll always be slight differences with money and market manipulation but the end result is the same as a settled contract, some win, some lose....well most lose..some win..

Lets not think for a second everyone here is possible to become millionaires...it wont work.. for a handfull of people to be rich, the majority has to be poor. FACT.

If we all collaborated to turn the markets in our favour.guess what..the big boys would move the goal post and change the game.

Winners make off the losers in life(inc markets)...In employment the boss, directors and shareholders get paid the most for doing the least. People on the ground floor work the hardest and get paid the least.

People just have to face the awful truth, some will make it...most wont.

 

[davidnmfarrell]

Lets not think for a second everyone here is possible to become millionaires...it wont work.. for a handfull of people to be rich, the majority has to be poor. FACT....Winners make off the losers in life(inc markets)...In employment the boss, directors and shareholders get paid the most for doing the least. People on the ground floor work the hardest and get paid the least.

I agree that everyone won't become a millionaire, but the idea that people's wealth is derived from other's poverty is demonstrably false. It's precisely because of this that we now discuss wealth issues using terms such as "relative poverty" - the low wage earners today are clearly wealthier than their predecessors.

You may think that bosses and directors do the least, but in a meritocratic company, the senior managers and directors contribute a lot more value than an unskilled worker. Who works harder is less important than who adds more value: however my personal experience suggests that the directors are the hardest working of all people - most of the senior management in my company regularly work 16 hour days, give up time on weekends, and quite frankly work their guts out.

 

[Profitaker]

I think it's the case that prices paid for goods are not derived from an objective and rational value calculation, but they're simply market prices - which are manifestations of the perceived utility of the goods, by potential buyers and sellers. Therefore, because share prices are derived from perceived utility, they cannot be zero-sum.

I disagree

I think you're alluding to asset price bubbles (?) and I would say that buyers are driven by the "bigger fool" mentality but shareholders rarely cash-out paper profits at the top. Taken in isolation, such bubbles may not be zero-sum. But in the grand scheme of things they are.

A good example is the internet bubble, where ridiculously high valuations in that sector caused ridiculously low valuations of more "conventional" sectors and stocks, i.e., the internet bubble phenomenon was, ultimately zero-sum.

Totally agree Lee Sheppards interpretation of the awful truth.

 

[new_trader]

Profit taker has hit the nail on the head, thats pretty much the short and tall of it and how the markets work. Of course they'll always be slight differences with money and market manipulation but the end result is the same as a settled contract, some win, some lose....well most lose..some win..

Lets not think for a second everyone here is possible to become millionaires...it wont work.. for a handfull of people to be rich, the majority has to be poor. FACT.

If we all collaborated to turn the markets in our favour.guess what..the big boys would move the goal post and change the game.

Winners make off the losers in life(inc markets)...In employment the boss, directors and shareholders get paid the most for doing the least. People on the ground floor work the hardest and get paid the least.

People just have to face the awful truth, some will make it...most wont.

Ok. Some will make it and most won't, but everything I read doesn't define that as being zero sum. Zero sum means that in order for a participant to win X amount the other participant(s) must lose precisely X amount.

 

[arabianights]

Options are zero-sum, period. This has been clearly explained on this thread and should not be difficult to grasp.

Stock markets however, are very close to zero-sum and needs a little more thought.....

If Widget Plc went from selling 50 widgets/week to selling 150 then this will be offset by it's competitor(s) selling 100 widgets/week less. If the total market for widgets has increased then this will be offset by a similar value decrease in another market. So in the grand scheme of things where one company and it's investors gain, somebody, somehwere, will lose.

At one point there were a few thousand humans and a market for, I dunno, sticks and grapes or something.

It only becomes zero-sum when you start talking about conservation of mass-energy, the earth being swallowed by the sun, or other absurd hypotheticals.