How is the stock market NOT zero-sum?

[Phone Booth]

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There are many instances where the equity markets DO NOT represent a zero sum game.

While most trading represents zero sum activity you must remember how the shares came onto the market in the first place. Mostly they became tradeable via IPOs' and those are most definitely NOT zero sum transactions.

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True, but we're talking about typical secondary market trading (I wrote about the exceptions earlier). Anything that affects the employees or management is not zero-sum. Also, these activities do not generally affect the rest of us.

[T50_Omaha8]

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There are many instances where the equity markets DO NOT represent a zero sum game.

While most trading represents zero sum activity you must remember how the shares came onto the market in the first place. Mostly they became tradeable via IPOs' and those are most definitely NOT zero sum transactions.

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True, but we're talking about typical secondary market trading (I wrote about the exceptions earlier). Anything that affects the employees or management is not zero-sum. Also, these activities do not generally affect the rest of us.

[/ QUOTE ]But would anybody buy a stock if there were no secondary market that would ensure the stock would be appropriately valued over its duration?

In that sense, the zero-sumness of the secondary market creates value for the IPO.

[ArturiusX]

The trouble is, buying and selling effects the future price.

This is why the stock market is zero sum. Effectively by selling, everyones share price goes down, unless someone decides to buy in. When there's an inventory clean out for whatever reason, those who bought in later (it could be a family or a college kid looking to invest to retire), essentially lose out. If you freeze the frame right there and look at the winners and losers, it exists. Some people profited off the loss of those late entrants.

The market has an illusion of everyone winning because of the two phenomenon's I listed. People will re-invest dividends and the culture is ensuring new people are always investing more into the stock market using IRA or whatever the world equivalent is. The intrinsic value of the company thats returned to the consumer is irrelevant from the equation, since re-investment will not lead to a cumulative effect unless the company is re-issuing or something a little different. Because of this, dividend payments are irrespective of each other. You should be taking dividends as a neutral cash payment.

This makes us all speculators; speculators in the sense that, we're speculating our investing culture is going to stay constant will we retire or sell out.

[Mark1808]

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A zero sum game occurs when you have a fixed settlement at a fixed date where anyone who created a long or short position must settle up. This means at some point ALL market participants must offset their transcation resulting in a zero sum game. In stocks their is no fixed settlement or expiration at which time ALL holders must settle their positions.

Just think of a simple example of acompany issuing 1 million shares at $10 who must cover (buy back) that position in one year. If they buy back at $15, they lost $5 million and the buyers made $5 million. The company and its value is a seperate issue, in terms of the stock trading of that company you would have had a zero sum game.

Now take the case where they don't have to buy back. One year from now several thousand shares have traded the price up to $15. As a whole buyers are up $5 million and no one has to ever buy back in that original position that was sold to the public so their is no offsetting stock loss.

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Why stop there? Shouldn't the US government also offer to buy back the US dollars for some sort of fixed-value asset? First, you are way too fixated upon US dollars as a measure of value. Second, none of those trades have any bearing on the total value - if you play poker with stock certificates, does the game suddenly become non zero sum?

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Yes poker does become a non zero sum game (for the holders of stock certificates) if players sell shares in themselves to finance their poker.

Lets say 9 players sell a $1,000 stake in themselves to outside investors. Those shares trade based on the fortunes of the player, people bid up the shares of expected winning players and sell off the shares of expected losing players.

Lets suppose at the end of a week 8 players lost everything and the last player has all the money. The stocks of those 8 players may or may not be zero based on their prospects of getting further financing and perhaps winning in the future. The shares of the winning player could be worth more or less than the $9,000 accumulated based on his expected ability to find new games and make more money.

To summarize since the shares never have a forced settlement date, they can trade above and below their underlying value without winners (in stock value) equaling losers. If the investors were forced to settle at a predetrmined time for the value of stack sizes then you would have a zero sum game with winners equaling losers.

[David Sklansky]

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Another point:

If everyone were buying and selling stocks for the same reasons, say that they believe they would either go up or down in the next day, then clearly they must make opposite speculations, and one of them must be wrong. Hence, one guy will lose money.

But that isn't why everyone buys stocks; people have different time horizons over which they make guesses. Lets say that you believe a stock will go down tomorrow and sell it to me today, and I buy it because I believe it will go up in ten years. Clearly, both of us can be right in that case.

I'm totally shooting from the hip here, BTW.

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You sure are. If the guy who believes the stock will go down tomorrow is right, the guy who buys it from him today is wrong, regardless of how right he might be about the long term prospects.

[Mark1808]

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Another point:

If everyone were buying and selling stocks for the same reasons, say that they believe they would either go up or down in the next day, then clearly they must make opposite speculations, and one of them must be wrong. Hence, one guy will lose money.

But that isn't why everyone buys stocks; people have different time horizons over which they make guesses. Lets say that you believe a stock will go down tomorrow and sell it to me today, and I buy it because I believe it will go up in ten years. Clearly, both of us can be right in that case.

I'm totally shooting from the hip here, BTW.

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You sure are. If the guy who believes the stock will go down tomorrow is right, the guy who buys it from him today is wrong, regardless of how right he might be about the long term prospects.

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Warren Buffett might take exception to that. If I buy a dollar bill from you today for 50 cents, is that wrong if tomorrow I can buy a dollar bill for 40 cents from someone else?

[David Sklansky]

If a poker game where the house adds three dollars to each pot, rather than raking it three dollars, is an example of a non zero sum game, than so is the stock market. Here is why:

Sticking with poker for a minute, imagine two players all in before the last card resulting in them exposing their hands to make a deal. A is a bit more astute and gets his opponents to accept an average of 25 cents less than they should. His 25 cent gain is their loss but they still made an average of $1.25 BECAUSE they played the pot. (Assuming equal skill).

Same with the stock market. As long as we all agree that in the long run it increases in value more than totally safe investments. (And we ignore short selling).

In the aggregate any buyer of stock is taking advantage of any seller. But that seller had to buy the stock in the first place so he gained there. And when he sells he isn't actually losing money but is just giving up his opportunity of winning more. He has simply quit the stock poker game with the reverse rake.

As for who provided the reverse rake, the answer of course is the company that made the initial public offering. Add them into the equation and you could call it zero sum.

[David Sklansky]

Obviously an exception occurs if there is no limit to my funds and a limit to how much I can buy.

[Mark1808]

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If a poker game where the house adds three dollars to each pot, rather than raking it three dollars, is an example of a non zero sum game, than so is the stock market. Here is why:

Sticking with poker for a minute, imagine two players all in before the last card resulting in them exposing their hands to make a deal. A is a bit more astute and gets his opponents to accept an average of 25 cents less than they should. His 25 cent gain is their loss but they still made an average of $1.25 BECAUSE they played the pot. (Assuming equal skill).

Same with the stock market. As long as we all agree that in the long run it increases in value more than totally safe investments. (And we ignore short selling).

In the aggregate any buyer of stock is taking advantage of any seller. But that seller had to buy the stock in the first place so he gained there. And when he sells he isn't actually losing money but is just giving up his opportunity of winning more. He has simply quit the stock poker game with the reverse rake.

As for who provided the reverse rake, the answer of course is the company that made the initial public offering. Add them into the equation and you could call it zero sum.

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Since there is settlement at the end of the pot you have a zero sum game if you add the profits and losses of the house and both players. The house is a participant in the game.


It is the settlment at a finite time where price and value are equal that creates a zero sum game. Up until the point of settlement price can be far above or below value based on future expectations.

[Mark1808]

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Obviously an exception occurs if there is no limit to my funds and a limit to how much I can buy.

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Future outcomes of uncertain events should not be used to determine if your decison was wrong or right. Buying a dollar bill for 50 cents is not wrong no matter how low someone else may sell it even if is the only dollar you buy. Is it wrong to push all in for 10 times the pot with top set and get called and outdrawn by a flush draw? In the same vein is it wrong to buy a dollar bill for 50 cents if tomorrow you could buy it for 40 cents? No one knows what tomorrow's prices will be, this does not mean that one can't make an educated guess as to whether a market price today represents a good buy or not. Tomorrow's price does not make that decison right or wrong unless tomorrow's price is the final settlement price that all stock holders must liquidate at.

http://www.buffettsecrets.com/mr-market.htm