Trading is almost NEVER a Zero Sum Game

[tmarket]

Read up on Lawrence Harris and find out which kind of trader you are and who you are trading against.

Trading is positive zero-sum game

Rational traders will not play a true zero-sum game in which they only value
trading profits. If all traders were all alike, all expected returns would be
zero and no one would benefit from trading. If some traders are more skilled
than others, the skilled traders would want to trade but the unskilled traders
would not. No one would trade. To explain why rational traders trade, we must
recognize that some people trade for more than just expected profits. People
trade to hedge risk, to move funds from one point in time to another, to
exchange assets, to earn an unconditional expected return, to learn whether they
can expect to profit from trading and to take pleasure from gambling. These
external benefits make trading a positive-sum game. If the external benefits to
trading are great enough, traders will trade even though they expect to lose.
Skilled traders will profit to the extent that unskilled traders are willing to
trade for external reasons. Market prices efficiently incorporate information
about value fundamentals when skilled traders obtain this information and trade
upon it in search of profits. The activity is profitable if the trading profits
exceed the costs of obtaining and acting upon the information. If no one traded
for external benefits, skilled traders could not profit from trading. They would
quit doing their research, they would not trade, and prices would not be
efficient.

This problem is known as the Grossman-Stiglitz paradox. Price efficiency depends
both on skilled traders and on traders who are willing or irrational losers. The
skilled traders make prices efficient and the losers pay for their research
efforts.

Unfortunately, for most of us, we have only been doing research.

 

[Don Bright]

Just a point. Stocks are companies...a company can make money and pay dividends or cause price to move up. This tends to negate the purist form of "zero sum game."

And if someone bought a stock from a short seller...and assume the price did not move...the short seller collects interest on the money generate from the short stock sale.

And, just for fun "Who is the biggest short seller of all?" The Company who issued the stock in the first place, right?

Just a couple of thoughts.


Don

 

[sbs17]

As long as one assumes that a stock will always go up, it is not a zero sum game. When one buys at 10 and sells at 15, he/she has made 5 dollars profit, and the person holding the stock at 15 now is holding the equivalent of 15 dollars. It's when the stock is no longer perceived as the equivalent of that money that someone loses. As long as the stock stays up in price and exists, everyone can be wealthier. Stocks are a creation of a new money equivalent.

 

[crgarcia]

Quote from mjl:

Trading is almost NEVER a Zero Sum Game

In a Zero Sum Game no money leaves the game unless it is won by one of the players-- so there must be at least one winner. In trading , money leaves the game to the spread.

This alone does not tell us weather a game like day trading stocks or FOREX is beatable, but it is important to understand.

If you and I bet one dollar each on the flip of a coin this is a Zero Sum Game. If I make you bet $2 to win only $1 this also is Zero Sum, however, you have a negative expectation as I am paying you too little when you win.. you must lose in the long run.

Poker is a game of skill and in a game where no money is taken by the operator, or given to the dealers as tips, it would be a Zero Sum Game and the best player would have a positive expectation. In most casinos, the fee for playing, and tips to the dealer will not stop a strong player from winning.

In horse race betting, even though there is some skill, it is incredibly hard to be a winner because too much money is taken by the track- often around 18%. The causes the odds on the horses to be much lower.

Trading is almost NEVER a Zero Sum Game. One big question in each form of trading (or situation) is can a skilled trader have an advantage that is large enough, despite his costs which includes things like the spread and commissions. Sometimes the answer is yes! Sometimes No!?

Trading it's a NEGATIVE sum game, because of broker commissions.