by Gaurangi Sharma
New to trading? Have all the questions buckled up in your head? One of the most debated questions regarding the stock market - Is the stock market investing a zero-sum game? If someone makes money in the stock market, does it mean that someone else must be losing money? We are going to demystify this. But firstly:
What is a Zero-Sum Game ?
Much of economic theory, a zero-sum game is one in which no wealth is created or destroyed. It's a situation where one person’s profit is equivalent to the other's loss so that the net change in wealth is Zero.
Relate to cutting a cake, where taking a larger piece reduces the amount of cake available for others as much as it increases the amount available for that taker, is a zero-sum game if all participants value each unit of cake equally.
The word "game" does not imply the model is valid only for recreational games. Politics, chess is called zero-sum.
Is Stock Market investing a Zero-Sum game ?
Most people think of the stock market as only owning shares in companies, but that’s not looking at the whole picture. Every asset that has trade value is a piece of stock, including cash. The bicycle that you bought 10 years ago is a piece of stock. Therefore, the stock market is essentially the entire economy.
The initial way to view the stock market is as a zero-sum game. With any stock trade, one side wins, because it buys security that increases in price, or because it sells one that declines. The other side loses, by the same amount. In aggregate, then, the stock market's collective trades amount to nothing at all. It's like the fruit was hanging low and you plucked it.
Trades are made based on future expectations, and traders have different risk preferences, a trade can be mutually beneficial. Investing longer term is a positive-sum situation because capital flows facilitation production, and jobs that then provide production, and jobs that then provide savings, and income that then provides investment to continue the cycle.
However, just because someone is selling their stock, doesn’t mean he is losing. He might have made substantial profits and was willing to book profits. And similarly, if one sells, there’s no reason to think that the next investor can’t profit too. Here, both the parties can be winners.
As the company expands and becomes more valuable, the stock market can increase the wealth of both the participants & economy over time. So the profit for the participants might not come from the stake of losses by other participants, but the value created by the company. If one sells a stock, there’s no reason to think that the next investor can’t profit too. As long as the business is performing well, the stock will keep on increasing value without anyone losing the money.
Overall, there doesn’t need to be one winner and other losers. The stock market provides an opportunity for a win-win situation for all.