A zero-sum game is one where the amount won by those who win exactly equals in aggregate the amount lost by those who lose. All forms of gambling are good examples of zero-sum games. The pot of money that is at stake in all games of chance will be divided up between the winners, the losers and the house. The house theoretically can be counted among the losers in any given instance but gaming is generally a good business to be in because the house typically wins many more times than it loses. The corollary to this is that gamblers typically as a group lose more than they win.
But what is happening is effectively a redistribution of the money used to make the bets. The total amount wagered remains unchanged before the wagers are struck and after the game has been concluded.
There has been something of an ongoing debate as to whether investing in the stock market is a zero-sum game. Those who say it is point to the fact that there is a winner and a loser to every trade. If an investor buys a stock and it goes up, he/she has won and the person who sold the stock has lost in an equal amount. (We are leaving transaction costs out for the sake of simplicity). The winner and loser roles are reversed if the stock goes down.
Those who say that investing in the market is not a zero-sum game point to the fact that as the overall market tends to rise in value over time, therefore most investors are statistically predestined to be winners should they hold their positions over the long haul.
Our own thinking is that both both arguments have correct elements to them but do not tell the whole story. The second argument ignores the fact that when any seller cashes out a stock position and registers a big profit, the investor who buys the position actually takes a notional loss because theoretically he/she could also have bought in earlier at the lower price. The first argument misses the fact that dividend payments add to the return on investment with a stream of income in such a way that the "pot" is constantly sweetened, thereby increasing the overall return all investors beyond the simple capital gain of a purchase and later sale.
Hmmm...complicated stuff. What do you think? Is stock-trading a zero-sum game just like gambling? Or is there a qualitative difference in this form of risk-taking that allows more market participants to emerge as winners than those who find themselves taking losses?
This article was written jointly by Aidan J. McNamara and Martha A. Brozyna
Aidan McNamara is associate publisher at The Deal LLC in New York, publisher of the weekly financial magazine The Deal as well as The Daily Deal and TheDeal.com. He holds an MA (with distinction) in Area Studies (Eastern Europe and Russia) from the University of London, 1981 and a BA in German from the University of Manchester.
Martha A. Brozyna received a Ph.D. in history from the University of Southern California in 2005 and a BA in history and political science from Rutgers University where she graduated Phi Beta Kappa in 1995.
McNamara and Brozyna are the authors of Contrarian Ripple Trading: A Low-Risk Strategy to Profiting from Short-Term Stock Trades, scheduled for publication by John Wiley & Sons in October 2007. Martha Brozyna published Gender and Sexuality in the Middle Ages: A Medieval Source Documents Reader in 2005 (McFarland & Co.)
The authors have additional information on themselves and their forthcoming book at their website http://www.ridetheripples.com
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