A zero sum game is a situation where one person’s gain is equal to another person’s loss, so the total money inside the game for the players and participants is always a net change of zero as a whole unless money is removed or added to the game. The financial contract markets for futures and options are zero-sum game with millions of players around the world.
Zero-sum games are from game theory, but are less common than non-zero sum games. Poker and gambling are examples of what a zero sum game is because the sum of the amounts won by some players equals the losses from the others. The money at a poker table at the start of the game does not grow it is just redistributed to the winners from the losers by the end of the game. Another great example of a zero sum game is the casino business model as all of the casino’s profits come from the gambler’s losses and all the gamblers profits are taken from the casino.
Capitalism is an example of a non-zero sum game as creation of businesses, products, and jobs can be a benefit to everyone with lower product costs, higher paying jobs with more competition, and a rising quality of standard of living for the majority. Wealthy people do not take money from others they have to create value to earn it. An entrepreneur, employee, and customer can all win in their transactions.
Games like chess and tennis also fit the zero sum model because there is one winner and one loser and they are always equal. A lost chess piece benefits the opponent and points in tennis are scored for one person and against the other. One person’s loss is the other’s gain.
In the financial markets, option contracts and future contracts are examples of zero-sum games, excluding transaction costs, for every long contract their is someone short the same contract. Some one has to sell a contract to create open interest and someone has to buy it, there has to be a winner and a loser at all times. Contract markets are always equal with one long position and one short position on each side of every position at any time.
Brokers and market makers disrupt the perfect balance of money between winners and losers by taking commissions or profiting from the bid/ask spreads. But, for every person who profits on a contract’s value going in their direction, there is a counter-party the other side who loses when another profits.
A very common misconception held is that the stock market is a zero sum game. It isn’t, because there is not always an opposite short position for every long stock position. The underlying company that takes their stock public with the initial public offering is taking in the money from the sales of the stock into the market but they are not going short. When stocks IPO they never have to buy back to cover the stock as they are not sold short, shares are sold as equity ownership in the business. The issuing company can keep the capital raised, the company wins by raising capital to reinvest in the business by giving up an ownership percentage to the public for cash. Short positions can be opened up later on an IPO by traders and investors but the longs and shorts are not equal in the stock market as they are equity in a company not a contract.
In the stock market a long term investor can sell a long term holding for a profit to a day trader then the day trader can sell it later that same day for a profit so both the seller and the buyer made a profit on the same trade.
If investors or traders as a majority are long a stock that is trending up with minimum short interest then there can be more profits on the long side than there are losers on the short side. The company and the investors can all be profiting in stock making it a non-zero sum game.
When a company loses its market cap as a stock declines the money lost in value is not all made by short sellers because there is not 100% short interest. When a company market capitalization drops then that value evaporates as everyone can’t exit and lock in profits during a decline.
In the stock market money can be lost by the majority or made by the minority but in contract markets someone always makes money on one side of open interest.
A zero sum game is the inverse of a win-win situation. While a win-win agreement creates value for two people in a transaction a zero sum game always has the win of one person become the loss for another. A zero sum game also contrasts with lose-lose situations like prolonged stalemate wars between countries or even mutually destructive personal relationships where both people are worse off from the experience.
In trading short term profits come from the people taking the other side of your trade that do lose the next movement in price that you are on the right side of. The reason that trading is so difficult is because you have to take over someone’s position at the right time to benefit from what they are missing. The process you use to do this is what gives you an edge and can make you profitable over the long term.
In financial markets buyers and sellers are always equal during each trade and the time frame they are trading. For each trade there is always a buyer and a seller only the price changes. There are never more buyers than sellers in a market, price just moves until it finds the next buyer or seller in a trend. The time frame someone is investing or buying on determines if their decision or signal created profits between their entry and exit. In trading your entry is someone else’s exit and your exit is someone else’s entry. In zero sum markets like options, futures, and forex your losses are in some one else’s account as profits and your profits come from other’s losses.
