29
Mar
2011

Is the stock market really a zero-sum game?

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I see this statement all over the place when I read stock market blogs, info products, etc. that the stock market is a “zero sum” game, that for every trade there is a winner and a loser. This certainly seems the case today, where all market participants are obsessed primarily with the price action of a stock over ever smaller time frames.

The stock market is traditionally held to represent the epitome of the “free market”, if this is the case, does the “zero-sum” model hold up? Is it rational?

If the stock market is just another marketplace, how come the zero-sum analogy isn’t applied to all markets? When you go to the baker to buy a loaf of bread is one of you “the winner” and the other “the loser” the moment the transaction is consummated? If not there or in any other market transaction, then why is it so in the stock market?

It is because, as mentioned in our previous “paid to wait” post, today’s market participants are concerned primarily with future “price action” of a stock. This is more pronounced today than in the past. Historically most stock market returns usually come from dividends when they are re-invested. This is especially true in secular bear or sideways (rangebound) markets such as the one we’re in now (and likely to be in for another 10 years or so).

When all market participants are concerned with future price action only (the stock going up), then the market does become into a zero-sum game, and this is perhaps why the public markets have devolved into such a ruthless cutthroat battlefield where the dishonest thrive.

But here are 8 reasons why the stock market is or could not be a zero-sum game, in other words, below are situations wherein both sides of a transaction could in theory “win” and meet their own objectives:

  1. Diversifying holdings
  2. Short Covering
  3. Mutual Fund or Asset Allocation Rebalancing
  4. Buying for dividends (in which case your yield goes UP the cheaper you can buy the stock)
  5. A seller hitting his price target to a buyer hitting his buy target
  6. Differing time horizons between buyers and sellers
  7. Differing investment objectives between buyers and sellers (i.e. dividends vs. capital gains)
  8. Changing requirements (i.e. moving from saving for retirement into retirement)

In the climate we find ourselves in today, these situations are the minority, as most of the lemmings are on a treadmill chasing that next hot stock tip, piling into something because Jim Cramer told them to, or jumping ship because Joe Weisenthal is having a panic attack (“Gold tanks $2/oz!”)

When both sides of a transaction have coherent goals, it is possible for them to meet in the marketplace and trade at a mutually agreed upon price, and both can walk away deriving mutual benefit. This is in stark contrast to the lemming mentality, where everybody is just chasing after a quick buck like a zombie horde sniffing brains.

One response to “Is the stock market really a zero-sum game?”

  1. […] outlining why you think it is a zero-sum game when in practice it really isnt (for the average joe) http://rebootingcapitalism.com/2011/03/29/is-the-…zero-sum-game/ […]

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