Is The Stock Market A Zero-Sum Game: Individuals enter the stock market in the hope of making money out of it? You can ask any financial expert, and you will hear that investing in stocks is one of the best ways to build long-term wealth. However, the tricky thing with stocks is that their everyday movement is impossible to predict with 100% accuracy.
In the long run, the value can grow exponentially. Investors are required to stay invested for the long haul to capture the true value of the stock market. Resorting to a “buy and hold” strategy can help individuals achieve this goal.
While some individuals view stock markets as a place to generate wealth over the long term, some believe that stock market investing is a zero-sum game. This has often been highlighted by the media as well.
Long-term investors are often asked this question, “Is the stock market a zero-sum game?” So, in this article, we will discuss this concept in detail and try to reach a concrete solution. Read on to find out whether or not a stock market is a zero-sum game.
Zero-Sum Game – What Is It?
This discussion holds no value if the meaning of the zero-sum game is not fully understood. Zero-sum refers to a situation in which one person’s profit is equivalent to another person’s loss. Therefore, the net change in wealth is zero. Most of the time, this is cited in game theory.
Zero-sum games might have as few as 2 players or as many as millions. Simply put, a zero-sum game refers to a mathematical representation in game theory of a situation involving 2 sides, where the final result is an advantage for one side and the same amount of loss for the other.
Zero-sum games can be found in many contexts. Poker and gambling are some examples of zero-sum games as the sum of the amounts won by some players are equal to the combined losses of the others who played the game. Other games like chess and tennis can also be termed zero-sum games.
This is because one party is declared a winner and one a loser. The reason these games are called zero-sum is that when you add gains made by the winner to the losses incurred by the losing party, it will add up to zero.
Therefore, the defining characteristic of a zero-sum game is that someone has to lose for someone to be declared a winner. Derivative trades can also be cited as zero-sum games. Every dollar earned in the derivatives transaction has to be lost by some other party who is involved in the transaction.
The Derivative Market Is A Zero-Sum Market – Why Is It So?
If someone asks you, “Is the stock market a zero-sum game,” you can correct them by saying that the derivative market is what you are referring to. The derivatives market is a 100% percent zero-sum game. Actually, it can be negative if slippages and commissions are included.
This is because if an option or a futures contract is bought, there must be a seller on the other side of the table. The seller is either selling a long position or he/she is initiating a short position. This is the main reason that most traders in the derivative markets end up losing money.
Stock Market Investing Is A Long-Term Thing
For some investors, stock markets tend to look like a zero-sum game in the short term. This is because short-term investors make speculations where one trader profits at the expense of another. On the contrary, stock markets go up in the long run. Several participants in the share market have a proven track record of generating wealth over the long term.
For example, we all have seen how Sensex touched its lifetime high when COVID restrictions were removed. This happened only in around 1.5 years. Here all investors who believed in long-term investing gained. Though in the short run, stock investing can look a little like speculating, in the long run, it tends to deliver significant gains.
When an investor buys a stock, he/she is essentially purchasing companies that grow along with the economy. As these companies grow over time, profits follow the growth path. Some of the leading and renowned companies in India have grown over time and shareholders of these companies have seen significant benefits.
If new investors or amateurs plan well, they can also grow their wealth over time in the next several years. If beginners have no idea where to invest, they can choose to invest their capital in equity mutual funds as the fund manager does most of the work.
Is Day Trading A Zero-Sum Game?
Day trading involves opening and closing deals within a single day, so if one person makes money on the stock market that day, the other will also make money that day. This basically sums up the definition of a zero-sum game. Thus it can be said that day trading is a zero-sum game.
To Sum Up
Coming back to our original question, is the stock market a zero-sum game? Some people view that shares of a company are the same as a coin in a coin toss or as chips in casinos. Truth is, if the stock belongs to a company that is financially strong, it can help make everyone richer.
Therefore, if an investor wins and makes profits, he/she is not making money at the expense of someone else. That investor is getting richer because the company has made significant improvements in profits and those profits are helping the share price.
In the same way, the stock of a weak company impacts the investor’s wealth. An investor incurs losses not because someone else is profiting, but due to the fact that the company is losing money. This very fact is impacting share prices.
Therefore, the stock market can be a positive-sum game for individuals choosing solid stocks and a negative-sum game for investors choosing bad stocks.
More often than not, the stock market tends to move upwards, except for some down years. If an investor sells his/her shares and books a profit, it is not somebody else’s loss. If someone had to incur a loss at the expense of someone else’s gain, the stock market would not have increased significantly over time.
We hope the above article answers your question, “Is the stock market a zero-sum game?” In financial markets parlance, trading futures and options are considered a zero-sum game. This is because, for every rupee an investor spends, there will be a rupee gained and vice versa.
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