I recently got a zero sum question in regards to the stock market.
The one question I cannot seem to find the definitive answer to is this:
Is the Stock Market a “zero sum” entity?
I have done a lot of online research the last week or so trying to answer this question. Unfortunately, there are too many differing views on this subject and I have not yet found confirmation.
I’ve addressed the general zero sum question previously in the post The Zero Sum Game. Let me tackle stocks specifically here, however.
First, a zero some game is one in which there must be an equal loser for each winner. Basically, it’s a matched pair where there can never be any net gain or loss in value in the aggregate because increases in value for one side are offset by decrease in value on the other side.
Think of it like this. Billy and Bobby each have 5 balls for a total of 10. They are in an enclosed space, so no new balls can be introduced and no balls removed. In order for Billy to have 6 balls, one must be taken away from Bobby, who will be left with 4.
In trading terms, zero sum mean that there is a short for every long. The futures market is a perfect example of this. Futures are contracts for an exchange to take place at a later date. There are two sides to each contract – a long and a short. The long benefits from an increase in the value of the contract, and suffers from a decrease. It’s vice versa for the short, on a dollar for dollar basis. What the long gains comes from the losses of the short.
In asset markets, however, there isn’t necessarily a short on the other side of a long position. In fact, in most cases there isn’t. That means generally speaking, someone who owns the stock will be the sole winner or loser should the value of the stock change. No one else is mirroring that performance on the other side. It’s like owning a house. There’s no short on the other side of a home purchase, so the home owner is the only one impacted by changing values in the property.
I have heard some contend that the seller of the stock (or house) is in fact like a short because of the forgone gains or losses. That’s an opportunity cost argument, though, and one which really cannot be pursued in any reasonable fashion for the simple reason that we don’t know what the seller is doing with the funds, nor do we know if the buyer is actually making the best investment with her/his money.
Others might contend that if you only look at “trading” then stocks are zero sum. Again, since there doesn’t have to be a short on the other side of a stock long then it’s not really zero sum. Besides, traders buy stocks from investors and investors buy stocks from traders, so you cannot look at the groups in isolation.
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About the Author
John Forman, author of this blog, has traded for more than 20 years, is a professional market analyst, and authored The Essentials of Trading. He is an active participant in trading forums, consults for trading related businesses, as published literally dozens of trading articles, and has been quoted in a number of books and in the media.
** See John’s full bio.
