[JoshW]

Not as long as companies continue to produce value. The market goes up and no one HAS TO lose money in order for your stock to go up.

[Ganchrow]

Is the Stock Market a zero Sum game?

The short answer is yes and no.

The stock market itself is nothing more than an exchange where people trade cash for partial ownership of some conglomeration of capital (you can think of capital as "that which aids in the production of goods or the delivery of services" -- examples of such might include items as diverse as computer hardware or software, farming implements, hammers, office space, mops, microscopes, trademarks, or patents). The amount of cash required to purchase said conglomeration is solely determined through its supply and demand as well as by the infrastructure of the market itself. The stock market is what's known as a secondary market in that buyers or seller of capital do not transact directly with the company itself (with the exception of share buyback programs) but rather with other members of the public (where a member may be either an individual or a conglomeration of individuals such as hedge funds, mutual funds, or pension funds).

As such the stock market is a zero sum game. If (agents for) you buy a share of IBM from (agents for) me at $80 on the floor of the New York Stock Exchange and the share price later rises by $1, then you've made $1 and I have lost $1 (of potential profit – this is known as “opportunity cost”). There's no way to make (or lose) money buying or selling a stock on a secondary exchange without it costing (or benefiting) some one else an equal amount (putting aside the dead weight loss of commissions and exchange fees).

Now comes the however. The stock market is not the only place to way to purchase stock. There’s also a mechanism for purchasing stock in the United States (and every country has an equivalent) called the public offering market. Broadly speaking, there are two types of public offerings: initial public offerings (known as IPO’s) and secondary public offerings (which I suppose might be known as SPO’s, although I can’t honestly recall if I’ve ever heard that acronym used). The essential difference between an IPO and an SPO is that the former represents a public offering of a stock which had not previously been publicly traded while the latter represents a public offering of stock which had previously been publicly traded. But what exactly is a “public offering”?

The term “public offering” is itself a bit of a misnomer. Public offerings are really not all that public. In general, it’s much harder to purchase stock through a public offering than it is to purchase stock on a stock exchange. I won’t go in to the gory details of how public offerings work either in theory or in practice, but the defining characteristic of all public offerings is that they represent the mechanism by which companies may sell previously unissued shares of stock to (certain elements of) the public.

Now it’s my contention that public offerings in general are not zero sum games but are in fact positive sum games. To best explain we first need to get away from the abstraction of a publicly traded corporation and consider a hypothetical company. Typically, when microeconomists discuss hypothetical firms they use the term “widgets” as an abstraction for the generic goods produced. However, because this is a sportsbook review site let’s consider a small bookmaking operation.

When this hypothetical operation first begins the company is just a single person – the owner/operator -- let’s call his Bill. Bill has no equipment and no money. All Bill owns is the shirt on his back and the shoes on his feet (if you like you can also assume Bill owns a pair of pants and some underwear). Because he has no money the only way he can operate is as the agent of another larger bookie. Bill books bets at -109 and then lays them off on the other bookie at -110. Because he doesn’t even own a pen he can only book as many bets as he can remember. He doesn’t make very much money doing but at least he’s able to survive. Now after doing this for several weeks he’s able to sock away enough extra cash to buy a few pens and some paper. (This is an example of “capital”.) After Bill does this he finds he’s able to book significantly more bets per week and increase his profits substantially. Then it further dawn on Bill that he can start making much more money by buying or renting office space, telephones, computers, software, and by having access to a credit line so that can operate independently of the larger bookmaker. Unfortunately, Bill realizes that it might take him years to generate enough profits to allow him to grow his burgeoning company as he might wish.

So what’s Bill to do? Big dreams but small pockets and all that. So Bill thinks for a while and decides to hit the pavement and find some investors. He tells his potential investors that for every $10 they invest with him they can own 0.01% of the company. (By doing this Bill has implicitly valued the entire concern at $100,000.) Because a lot of people believe in Bill’s business plan and because Bill’s such a top-notch salesperson, he’s quickly able to sell off 10% of his holdings and come up with $10,000 of operating capital.

This is the equivalent of a public offering. If Bill’s company is successful then he’ll be able to generate good returns for his investor while increasing his own profits all because of the equipment he can purchase by virtue of the cash infusion. In short this is a win/win scenario. Bill makes money and the investors make money. Without the investors Bill could not so much money and without Bill the investors couldn’t make money.

So now let’s relate this back to the original concept of a stock market. Remember that Bill’s investors were able to purchase “0.01% of the company” for every $10 they invested. But what exactly does this concept of “owning 0.01% of a company” actually mean? As company operator Bill is certainly entitled to pay himself a fair salary, and as 90% owner Bill is certainly entitled to 90% of profits net of capital expenditures. But what if there are no profits net of capital expenditures? In other words, what if Bill as operator decides to reinvest all the profits back into the company (perhaps establishing or setting up a health plan so as to attract better employees)? If this occurs then Bill’s investors won’t be able to get paid. Certainly, the value of their holdings within the company might well increase but if they themselves were concerned about liquidity they would be unable to extract any cash from their investment and potentially unable to pay their own bills or fund what they might consider ultimately a superior investment. But enter the stock exchange. If Bill’s stock were publicly traded then any of Bill’s investors could sell his ownership in the company at the secondary market even if Bill could neither pay out dividends nor could he repurchase his company shares.

So therein lies the interplay. The very existence of stock exchanges make it easier for companies to raise money from the public. Companies don’t raise money on stock exchanges but the exchanges do give potential investors the security of knowing that they can readily translate their ownership in a company into hard currency if the need should ever arise. This security translates into greater in fundraising. Ask yourself this question: With whom would you rather invest money -- a company from which you can only cash out your investment on their terms, or a company from which you can cash out your investment at any time any without any interference?

So is a stock market a zero sum game? Yes and no.

Yes, it is a zero sum game insofar as an exchange devoid of any new issues does not present any opportunities for market participants to generate income in excess of that lost by other market participants.

And no, it’s not a zero sum game in that stock markets allow corporations the opportunity to more easily raise capital from the public. And, as lakerfan writes, if these companies can use this capital to create value, then ultimately everyone wins.

[RickySteve]

The short answer is yes and no.

<>

The answer is absolutely no, contrary to what this long-winded charlatan claims. There *IS* vig in the financial markets; it comes in the form of transaction costs. Every trade you make, or is made on your behalf, you're paying someone to execute it. This erodes your earnings, exactly as the bookie's vig or the rake in poker does. These costs can and must be minimized in order to achieve the optimal risk-adjusted return. This is most effectively done by investing in the entire market, or large segments of it, via index and exchange-traded funds. These provide minimal risk for the highest expected return, and, most importantly, have minimal transaction costs.

It is EXTREMELY difficult - many argue it is impossible - to beat the market. It can only be achieved if you possess information not available to the entire market. The best you can expect to earn is what the market earns as a whole, while paying as little as possible to be in the game.

[Ganchrow]

The answer is absolutely no, contrary to what this long-winded charlatan claims. There *IS* vig in the financial markets; it comes in the form of transaction costs. Every trade you make, or is made on your behalf, you're paying someone to execute it. This erodes your earnings, exactly as the bookie's vig or the rake in poker does. These costs can and must be minimized in order to achieve the optimal risk-adjusted return. This is most effectively done by investing in the entire market, or large segments of it, via index and exchange-traded funds. These provide minimal risk for the highest expected return, and, most importantly, have minimal transaction costs.

It is EXTREMELY difficult - many argue it is impossible - to beat the market. It can only be achieved if you possess information not available to the entire market. The best you can expect to earn is what the market earns as a whole, while paying as little as possible to be in the game.

Well I might be long-winded but I don't think I'm a charlatan. Please tell me how I'm wrong about this.

There's no question that commissions impact the performance of frequent traders (and for quantitative traders often quite drastically) but that's much beside the point when looking at the typical market participant (if you had read my long-winded post you would have noticed that I did make brief mention of the dead weight loss of transaction costs). This is of course especially true when investing long-term in ETFs or index funds. Although strictly speaking, you are correct that commissions would tend to make the market negative sum the reality is that commissions are a de minimus expense for the typical investor.

Regardless, your discussion of index funds, market efficiency, and risk, while certainly accurate, are highly irrelevant to the issue at hand. It is certainly possble for a market to be even strongly efficient and simulataneouly be zero sum, positive sum, or negative sum. The same is true for risk. A risky market may just as well be negative sum as positive sum.

[RickySteve]

When you buy an equity, is the total price you pay exactly equal to what the seller receives?

[Ganchrow]

When you buy an equity, is the total price you pay exactly equal to what the seller receives?

As I wrote in my previous post, "Although strictly speaking, you are correct that commissions would tend to make the market negative sum the reality is that commissions are a de minimus expense for the typical investor."

But again, this is not the most salient point.

[Ganchrow]

After considering this further, I think I should probably clarify my original long-winded post by stating that while the "stock market" devoid of new issues represents a zero-sum game, "stock trading" as an activity does not. However, this becomes decreasingly pertinent the further one move along the continuum from high frequency trader to long term investor.

[RickySteve]

The topic of the thread is whether the stock market is zero sum or not. You said "yes and no," which is asinine. It is absolutely, unequivocally not. A case can be made that it is net positive or net negative, but there is no basis whatsoever for saying that it IS zero sum.
The market as a whole has been historically net positive. Value appears to have been created from the capital raised through stock issue.
At the same time, any given exchange of an equity, and the market is only a series of individual transactions, is net negative. A deficit is created by trading fees. The amount gained by the seller does not equal the amount given by the buyer, and the difference is money removed from the market. The equity purchased must generate enough value to overcome this handicap in order for the buyer to earn a positive return on his investment. Further, the market as a whole must produce value in excess all of these collective fees in order to remain net positive.
Transaction fees are a very real and considerable drag on the performance of the market. Furthermore, they are hugely significant with regard to the "typical" investor who either trades too much at low volume, or buys mutual funds which generate enormous trading costs as well as management fees. By default, transaction fees make the market a net negative non-zero-sum proposition. Market performance may or may not generate enough value to offset these costs, but nonetheless the market is NOT a zero sum game.

[Ganchrow]

The topic of the thread is whether the stock market is zero sum or not. You said "yes and no," which is asinine. It is absolutely, unequivocally not. A case can be made that it is net positive or net negative, but there is no basis whatsoever for saying that it IS zero sum.
The market as a whole has been historically net positive. Value appears to have been created from the capital raised through stock issue.
At the same time, any given exchange of an equity, and the market is only a series of individual transactions, is net negative. A deficit is created by trading fees. The amount gained by the seller does not equal the amount given by the buyer, and the difference is money removed from the market. The equity purchased must generate enough value to overcome this handicap in order for the buyer to earn a positive return on his investment. Further, the market as a whole must produce value in excess all of these collective fees in order to remain net positive.
Transaction fees are a very real and considerable drag on the performance of the market. Furthermore, they are hugely significant with regard to the "typical" investor who either trades too much at low volume, or buys mutual funds which generate enormous trading costs as well as management fees. By default, transaction fees make the market a net negative non-zero-sum proposition. Market performance may or may not generate enough value to offset these costs, but nonetheless the market is NOT a zero sum game.

You're being exceptionally picayune here and I think you're either missing the point or choosing to ignore it. Yes, commissions and exchange fees do exist and yes they do cause the market to be transactionally negative sum. But in terms of the original question the effect is quite insubstantial.

The simplification of assuming no transaction costs serves mainly to elucidate the central thesis-- namely, that contrary to commonly held belief the market devoid of new issues is NOT positive sum no matter how much value might be created by listed companies and further that the market becomes positive sum only when public offerings are taken into account. That commissions do have a slight drag on market performance should be readily apparent and is largely irrelevant to the thrust of the argument.

Of course if it makes you feel any better you can substitute in the phrase "very slighly negative sum" for "zero sum" in my first post. Or you could just simply choose to "put ... aside the dead weight loss of commissions and exchange fees" as I had already implored.

Either way ...

[datek23]

The stock market has many values and hidden values and a lot of misundertandings to a average investors.

For example, it strictly in terms of Market Cap Value, Microsoft is 277 billion and GE are around 344 billion marketcap however in reality they are not worth that much since we are doing stock market talk.

In terms of overall assets In the USA, Chrysler, Ford, and GM have the assets in the hundreds of billions in real reality but worth anywhere 10 times less in the stock market marketcap than GE and Microsoft.

In terms of oversales sales, GE, Walmart, GM. GE has the marketcap, GM is high in assets, Walmart is high in sales, Microsoft is high on demand and quality.

So in many ways the stock market really mixes a lot of information. So always look at different sources when you invest. Stock market doesn't alwayspaint an accurate picture.

[RickySteve]

Now I have to teach you English in addition to economics?

"Affect" makes no sense as a noun the way you've used it. The word you mean is "effect." Maybe you shouldn't try so hard to sound erudite. Honestly, it's very "picayune" of you.

Read this: http://ezinearticles.com/?Zero-Sum-Game&id=35525
As you can see, it clearly addresses the topic of the thread along the same line of reasoning I provided. You may also note that the author happens to provide support for your convoluted argument regarding new stock issues. The point is, the stock market is NOT(!!!!!) zero-sum BECAUSE OF transaction costs. You can make the comically dubious assertion that these costs are trivial(they are profound), but nonetheless, they are there. Two people flipping a coin at even money odds are playing a zero sum game. Two people flipping a coin for a profit of $.999 per dollar bet are NOT playing a zero sum game. Eventually both players will go broke. Note that this is a .1% vig. Good luck making investments with costs that low.

[Ganchrow]

"Affect" makes no sense as a noun the way you've used it. The word you mean is "effect." Maybe you shouldn't try so hard to sound erudite. Honestly, it's very "picayune" of you.

You're right. I've modified the post. My apologies. What can I say? I was tired. Although I still don't see how this is even slightly germane to the topic at hand.

Read this: http://ezinearticles.com/?Zero-Sum-Game&id=35525
As you can see, it clearly addresses the topic of the thread along the same line of reasoning I provided. You may also note that the author happens to provide support for your convoluted argument regarding new stock issues. The point is, the stock market is NOT(!!!!!) zero-sum BECAUSE OF transaction costs. You can make the comically dubious assertion that these costs are trivial(they are profound), but nonetheless, they are there. Two people flipping a coin at even money odds are playing a zero sum game. Two people flipping a coin for a profit of $.999 per dollar bet are NOT playing a zero sum game. Eventually both players will go broke. Note that this is a .1% vig. Good luck making investments with costs that low.

I don't know from where your hostility is coming. If you want to debate the issues I've brought up we can do so in a civilized fashion, but if it's just going to be more of the same ad hominem attacks and off-point arguments which ignore my central theseis and clearly stated assumptions, then please don't waste your time. I know I certainly won't waste any more of mine.

I've been in the equity derivatives business for eleven years now, having started on Wall Street as a quant trader after having finished grad school in economics. For the past three years I've run my own quantitative hedge fund and have been a guest lecturer in quantitative finance at two prominent universities in New York. I do know a fair amount about the topic at hand. Maybe give me a little benefit of the doubt before launching into another tirade?

Understand that I'm not claiming that you're wrong here (you aren't), it's just that you're missing the point by sophomorically focusing on the mundane. If the only pertinent question were whether the market were negative sum or zero sum then describing it as negative sum would be on point. But that's an uninteresting discussion. The interesting discsusion is whether the market net of commsissions is positive sum (as the second poster argued) or zero sum. And the answer to that question as I believe I've adequately argued is both yes and no. Certainly commissions do create a dead weight loss but focusing on that merely serves to obfuscate the most relevant issues.

This is very common within the scientific community. One quite often makes simplifying assumptions so as to better focus on the core issues without clouding a topic with what are largely extraneous issues. I freely admit that this is what I've done. I'm quite sorry if this has somehow offended your refined sensibilities.

[Ganchrow]

And just for the record, a commission of 10bps per trade would be considered rather high in today's trading environment.

[imgv94]

I made money in the market!!

ganchrow you are a smart individual!!