9/2/11

I've been thinking about this question for a while and I want to ask your opinions.
Stock market - No, this market is not zero-sum just because of the dividends. Manufacturing companies create value by turning raw materials into finished goods. Something that was originally worth little has been transformed into something worth more. Service companies create value by tapping into human capital. A consultant creates value by giving advice. His advice is worth money, and the consultant can give an infinite amount of advice. This value is retained by the company as profit. The profit gets distributed to shareholders. Therefore, the stock market is not a zero-sum game just because of the dividends.
http://www.investopedia.com/terms/z/zero-sumgame.a... first debunked myth on that web page is the stock market zero-sum myth. In essays I've read that argue that the stock market is zero-sum, the writer always neglects the dividends. You buy stocks to get the dividends! That's the whole point of stocks!
Options market - Yes, this is zero-sum.
Futures market - Yes, this is zero-sum.
Forex market - I'm not sure about this one.
Basically I think it's stupid to trade in the options or futures market because it's gambling. Poker is a zero-sum game and it's gambling. How can you assume that you are smarter than the rest of the market players? (The only way to profit in a zero-sum game is to be smarter than the other players). Everyone thinks they're a hot-shot, but due to statistics, most people will be average...

Comments (51)

9/2/11

"...all truth passes through three stages. First, it is ridiculed. Second, it is violently opposed. Third, it is accepted as being self-evident."

  • Schopenhauer
Financial Modeling
9/15/11

Correct me if I'm wrong, but I believe trading would be a zero-sum game only in a stagnant economy.

In a growing economy, trading does not HAVE to be a zero-sum game.

+Hammy

9/15/11

And what if another trader is hedging his position to a dual listed company, and isn't trading on the FX market to profit, but to remove his exposure to FX risk?

In my standard answer to these zero sum threads, a lot of people on the markets are not in there to make money, but are there so as to not lose that much money. (Starbucks and coffee etc.). The same reason you have home insurance I guess.

Also, as per your example, the second trader has not yet closed his position, he may or may not make a profit. It is perfectly possible to have a series of transactions where everyone makes a profit (obviously the last person's position is not yet closed), and vice versa. With money always coming into and leaving the market, it is impossible to pinpoint a moment in time and state the amount of money in this market is fixed, hence zero-sum is not really applicable, in my mind. A few will disagree with me though.

T

edit, the first trader hasnt closed his position yet either, he needs to reverse his transaction in your example.

9/2/11

options market no, it is possible for everyone to make a profit.
same with futures - remember some people do NOT purchase these with the intent of exercising them or selling them on.

Forex - same.

Poker is not necessarily gambling.

You also dont only buy stocks to get dividends.

Including the above, I disagree with just about everything else you wrote as well.

Have a good weekend. I hope for your sake IP doesnt find this thread.

9/15/11

When I say growing economy...I don't actually know if I mean increasing GDP or just even increasing stock indexes...

What I'm saying makes sense logically to me.

Good luck,
+Hammy

Best Response
9/15/11

Trazer has the right idea. OP posted what currently happens with most retail forex accounts (which as insanely popular right now). But, in theory, there are still traditional speculators and hedgers in the forex arena and those variances prevent it from being a zero-sum game.

Having said all that, there is also the counter-argument that all money, across the entire planet is a zero-sum game. I mean, no one is taking piles of cash and burning it into the atmosphere, right? Money merely transfers around - it's not created or destroyed. That's why most people have the OPs view of forex.

9/2/11

.

"The code of competence is the only system of morality that's on a gold standard." - Francisco d'Anconia

9/15/11
GentlemanJack:

Money merely transfers around - it's not created or destroyed.

+1 when the SB feature is working again

Get busy living

9/15/11
UFOinsider:
GentlemanJack:

Money merely transfers around - it's not created or destroyed.

+1 when the SB feature is working again

Thanks man, that's very cool of you

9/15/11
GentlemanJack:

Money merely transfers around - it's not created or destroyed.

Then where did the money go during the Dark Ages, the Great Depression, or the most recent financial crisis? If $4 trillion in shareholder value evaporates, who benefits from that other than short sellers and if $4 trillion ends up in the accounts of short sellers, wouldn't that prevent such wild swings in the economy, since every bear market is counteracted by an equally impressive bull market for short sellers?

Sorry for being such a Curious George. I'm just having a little trouble comprehending how this all adds up. Forgive me, I go to a non-target.

Competition is a sin.

-John D. Rockefeller

9/15/11
Hooked on LEAPS:
GentlemanJack:

Money merely transfers around - it's not created or destroyed.

Then where did the money go during the Dark Ages, the Great Depression, or the most recent financial crisis? If $4 trillion in shareholder value evaporates, who benefits from that other than short sellers and if $4 trillion ends up in the accounts of short sellers, wouldn't that prevent such wild swings in the economy, since every bear market is counteracted by an equally impressive bull market for short sellers?

Sorry for being such a Curious George. I'm just having a little trouble comprehending how this all adds up. Forgive me, I go to a non-target.

The 4 trillion you are talking about got split between short sellers and market devaluation. Stock prices reflect the last trade, however if the stock price of company x is 100 and a buyer offers 98 the sale will not go through, however if enough buyers are offering below the 100 market price it will put downward pressure on the share value. This can feed on itself and force prices down with out any slaes going on.

Follow the shit your fellow monkeys say @shitWSOsays

Life is hard, it's even harder when you're stupid - John Wayne

9/15/11
Hooked on LEAPS:
GentlemanJack:

Money merely transfers around - it's not created or destroyed.

Then where did the money go during the Dark Ages, the Great Depression, or the most recent financial crisis? If $4 trillion in shareholder value evaporates, who benefits from that other than short sellers and if $4 trillion ends up in the accounts of short sellers, wouldn't that prevent such wild swings in the economy, since every bear market is counteracted by an equally impressive bull market for short sellers?

Sorry for being such a Curious George. I'm just having a little trouble comprehending how this all adds up. Forgive me, I go to a non-target.

The money doesn't go away or "evaporate", it merely changes form. Money during the depression, for example, was spent on things that maybe don't exist now or exist in a different form. It has "morphed" from one good/market/person/country to another in a different shape or form. The horse & buggy market dollars gave way to the car market, the American market gave way to the Japanese market in the 80s, etc, etc. Again, no one out there is throwing cash into an incinerator - it merely moves around. Money has incredible "ebbs & flows" that make it a zero-sum game on a global basis.

Financial Modeling
9/2/11

long-term investing isn't once you consider dividends.

9/15/11

that it is not zero sum when you consider hedging. while technically one "loses" on one side of a trade, he is using it to reduce his risk so in that sense i would say it isn't completely zero sum

9/15/11

yep any market is a zero-sum game as money is not created in trading. risk is dispersed, but ultimately one trader's gain is another's loss.

9/15/11
aspiringtrader:

yep any market is a zero-sum game as money is not created in trading. risk is dispersed, but ultimately one trader's gain is another's loss.

I would think stocks are not a zero sum game in the long-run because as economies expand, technology improves, population increases, inflation continues, and workers continue to be more productive, I would think corporate profits would continue to rise and therefore stocks prices.

Not that I agree with everything about EMH or random walk theory, but if a blind monkey can make money by throwing darts at the S&P 500 over the last 100 years, I don't see a zero-sum game in stocks. On the other hand, I believe a monkey throwing darts at currencies in the long-term will end up about where he started.

Note: Not trying to turn this into another EMH thread and personally I believe markets are not efficient, but I do believe that over the course of 100 years, pending a nuclear holocaust, monkeys will still make money throwing darts at stocks, although not the same level of return as an arbitrage expert.

Competition is a sin.

-John D. Rockefeller

9/2/11

If you're trading options without delta hedging than yes it's zero sum, however in reality any market making desk is delta hedged so it is certainly possible for both clients and market makers to make money, even if they trade at mid.

Jack: They're all former investment bankers who were laid off from that economic crisis that Nancy Pelosi caused. They have zero real world skills, but God they work hard.
-30 Rock

9/15/11

I would think that trading derivatives would be a zero-sum game...

9/15/11

Its not a zero sum game, for the market to be a zero sum game every trade would have to be closed out when one side wants to close it out. However, the trade is just swapped around to different open trades when one side of a trade is closed.

Follow the shit your fellow monkeys say @shitWSOsays

Life is hard, it's even harder when you're stupid - John Wayne

9/15/11
heister:

Its not a zero sum game, for the market to be a zero sum game every trade would have to be closed out when one side wants to close it out. However, the trade is just swapped around to different open trades when one side of a trade is closed.

So, I'll sort of rephrase the question from what I said in my last post. Regardless of if you believe in EMH or not, a monkey throwing darts at the S&P 500 over a 100 year period will ultimately make money, but what would happen if the same experiment were done with the currency market?

Competition is a sin.

-John D. Rockefeller

9/15/11
Hooked on LEAPS:
heister:

Its not a zero sum game, for the market to be a zero sum game every trade would have to be closed out when one side wants to close it out. However, the trade is just swapped around to different open trades when one side of a trade is closed.

So, I'll sort of rephrase the question from what I said in my last post. Regardless of if you believe in EMH or not, a monkey throwing darts at the S&P 500 over a 100 year period will ultimately make money, but what would happen if the same experiment were done with the currency market?

I understand your view. However what makes it incorrect is the fact that more money is put into the market on anygiven day then is taken out. If you look at equity markets is the same way. For someone to win others have to loose. Even if the market overall wins someone has to buy into a bad position even if it makes money the amount of risk they are taking outweighs the reward.

Follow the shit your fellow monkeys say @shitWSOsays

Life is hard, it's even harder when you're stupid - John Wayne

9/15/11

checked out a vault message board just now (right before I sleep). Here is what the poster said:
Trading between professional traders is not a zero sum game. Most investors buy and sell at the bid/ask and the trader makes the spread at the expense of the individual investor. They also make money off of institutional investors the same way. Example: Trader A buys 100,000 CSCO at 61.10 from an institution. Trader A sells 100,000 CSCO for 61.20 to trader B. Trader B sells 100,000 CSCO to another institution for 61.30. Both traders net 10k.
Should have thought of this myself

9/15/11
yung_gekko:

I would think that trading derivatives would be a zero-sum game...

How so?

9/2/11

Options are not always zero sum. Listen to revsly. As long as you delta hedge options are in no way zero sum. Don't talk about things you have no clue about.

9/15/11

i think you're referring exclusively to prop trading...most of the banks do more client-based trading. as for prop trading, there are plenty of losers -- hedge funds go out of business all the time and lots of prop traders go broke trading PA.

9/15/11

^ typed on iPad, so pardon grammatical and other errs

9/2/11
leveRAGE.:

Options are not always zero sum. Listen to revsly. As long as you delta hedge options are in no way zero sum. Don't talk about things you have no clue about.

agree. Revsly is certified, I think he knows a thing or two about this.

looking for that pick-me-up to power through an all-nighter?
9/2/11
tobywashere:

I've been thinking about this question for a while and I want to ask your opinions.
Stock market - No, this market is not zero-sum just because of the dividends. Manufacturing companies create value by turning raw materials into finished goods. Something that was originally worth little has been transformed into something worth more. Service companies create value by tapping into human capital. A consultant creates value by giving advice. His advice is worth money, and the consultant can give an infinite amount of advice. This value is retained by the company as profit. The profit gets distributed to shareholders. Therefore, the stock market is not a zero-sum game just because of the dividends.
http://www.investopedia.com/terms/z/zero-sumgame.a... first debunked myth on that web page is the stock market zero-sum myth. In essays I've read that argue that the stock market is zero-sum, the writer always neglects the dividends. You buy stocks to get the dividends! That's the whole point of stocks!
Options market - Yes, this is zero-sum.
Futures market - Yes, this is zero-sum.
Forex market - I'm not sure about this one.
Basically I think it's stupid to trade in the options or futures market because it's gambling. Poker is a zero-sum game and it's gambling. How can you assume that you are smarter than the rest of the market players? (The only way to profit in a zero-sum game is to be smarter than the other players). Everyone thinks they're a hot-shot, but due to statistics, most people will be average...

LOL

9/15/11

for every gain that some big shot trader has, doesnt someone lose? yes.

Meaning, how can all the bb's generate profits on the floor? from spreading the clients

Bear in mind, I dont mean structuring, or sales (where you might be helping clients have exposure to certain sectors so they pay a premium for that). Aren't there SOME parties that have a loss on the floor? yes

If so, who are they? it's different from day to day and year to year

9/15/11

yes sure, in equities value is created (corporate revenue as work is done and goods are sold), so that money is brought into the market from elsewhere (buyers' pockets i suppose). but in FX as long as new money doesn't come into the market (new investors), it of course is a zero-sum game.

9/4/11

In the current economy where growth is not achieved through efficient allocation of capital but through a debt-financed ponzi scheme, I do think it is a zero-sum game, in the grand scheme of things.

9/15/11

I believe there exist participants in the capital markets that do not have the sole objective of making money. Many players want to hedge their exposure.

Sure a derivatives contract, unlike a stock which goes up on average over time, has one party that wins and one that loses. Still the losing party may not care that they lost since they wanted to lock in a price and they paid for that guaranteed price in the form of a loss.

Farmers and airlines remain two great examples of this. Still I do not think this behavior alone can explain all of these huge gains made by proprietary trading desks and hedge funds.

9/15/11

+1 to Heister for being the only one here who understands market realities.

9/15/11
illiniPride:

+1 to Heister for being the only one here who understands market realities.

I was slightly off, my equities example is different from FX. FX has counterpart for every trade. Unlike in equities where there is a buyer and a seller not just two people taking countering positions.

Follow the shit your fellow monkeys say @shitWSOsays

Life is hard, it's even harder when you're stupid - John Wayne

9/5/11

I remember getting into a pissing contest a year ago about this. Im sitting this one out.

"Oh the ladies ever tell you that you look like a fucking optical illusion" - Frank Slaughtery 25th Hour.

9/15/11

mrbubba which airlines r u thinking of? hah not US ones.

9/15/11

Thanks for the help guys, I will be awarding SB's when the system is up and running.

Competition is a sin.

-John D. Rockefeller

9/5/11

I've asked the same question and this is how it was explained to me: If everyone traded at mid with no spreads, the markets would absolutely be zero sum, even with delta hedged options. Delta hedged options allow the sell side and the customer to both profit when the customer makes the correct directional bet and the sell side makes the correct volatility bet. When delta hedging is a profitable endeavor, it comes at the expense of the counter party that you are delta hedging with.

Generally, sell side desks across BBs are profitable, with the exception of a few years and a few firms here and there. Overall, you see positive profits from sell side firms from their FICC and equity trading operations. This comes from the customers paying a premium for financial instruments to transfer their risk to the sell side firms. Think of coca cola hedging their cocoa or aluminum costs and reducing their exposure to EURUSD fluctuations. Another source of profits comes from fast money and real money that pay a premium for the sell side firms to make markets/take the other side of their bets. It is the job of the sell side firm to manage and hedge out these positions/risk they are taking on and this is what the premiums are for. If they are lucky, another customer will take the opposite side of the trade and they will make an almost risk free profit. If they are not, they will have to find more creative/dynamic ways of hedging out this risk over a longer time horizon. There are other sources of revenue/profits like Treasury primary dealing and transacting with central banks but when you add all these sources up, it about equals the sum of the PnL from trading of the sell side firms.

The deviations in profitability across firms is accounted for by the amount of business each sell side firm can bring in(this is where how good your sales team is comes into play). Also, there may be some slightly enhanced prop positions that allow slightly higher rates of profitability due to the volume of information/flow that the traders see but this isn't very significant, 10-15% of PnL if I had to put a number on it.

With regards to prop trading, there were desks pre dodd frank that focused solely on principal positions and dealt with no flow, and generated varying amounts of PnL(in some instances very substantial gains, in other cases, substantial loses). When it comes to this more proprietary aspect to the sell side, there is more of a zero sum element to it. As this aspect of sell side firms dies down, you will start to see less volatility in PnL compared to pre financial crisis

9/15/11

I know for a fact Southwest actually lost money on fuel forward contracts/futures recently. Maybe I should say that they do care, but they understand losses associated with hedging and remain willing to take them in the case that they would remove the volatility of their earnings created by fuel prices.

9/15/11
  1. It is impossible to create a global currency index. For it to be global currency index you have to sell something and buy currency. Ex. EUR/USD you are selling Euros against the Dollar. So for a currency index to work you would have to sell something against it. You could potentially create an index selling commodities in favor of different currencies, but you would be at the mercy of commodity prices.
  2. Equities are not a zero sum game because companies earn $$ and improve equity/issue dividends.
  3. Just because something is being used for hedging purposes does not mean it is not a zero sum game. For something to not be a zero sum game something has to be produced (ex. earnings)
  4. The fact that money is printed makes currency markets a negative sum game, your currencies loose buying power in real terms.
9/15/11

"Options are not always zero sum. Listen to revsly. As long as you delta hedge options are in no way zero sum. Don't talk about things you have no clue about."

If both cp's delta hedge correclty of course they are zero sum (worse actually b/c of slippage and transaction costs). In general, real money customers arent delta hedging, so it's possible for both the desk and the customer to profit (or lose)

9/15/11

point was for years no airline hedged except LUV.

9/15/11

There might be no losers - in such cases when economy is booming, and permanent new capital inflow is available. If there are no extra cash flows in the market, then there are lsoers as well as winners, definitely.
What is more, both parties in a transaction may actually be losers - if they close their respective positions at a breakeven level (due to additional negative impact of transaction costs).

9/15/11

Derivatives are a zero sum game. Anyone who wishes to purchase an option will have to be matched with someone who wishes to write that option. The purchase price the buyer of the contract pays is the premium the option writers earn (minus the spread that the market maker keeps).

Equities vary depending on the timeframe you are analyzing. Obviously at the micro level the market maker is indeed profiting at the buyer/seller's expense. However, over the longer term equities do not require the need to have a counter party in all transactions. For example, for every trader long X amount of stock there is no trader short X amount of stock. Thus, it isn't a zero sum game.

Foreign exchange is obviously a zero sum game. Every participant faces an existential exposure to this field. When someone goes long the EUR/USD, someone else has to take the opposing side (short the EUR/USD). Thus, that is a zero sum game.

So no, it doesn't have to do with the economy booming/busting. It has to do with the market.

9/15/11
mahras2:

Derivatives are a zero sum game. Anyone who wishes to purchase an option will have to be matched with someone who wishes to write that option. The purchase price the buyer of the contract pays is the premium the option writers earn (minus the spread that the market maker keeps).

I think the original poster was asking along the lines of "how do all of the banks keep making money in trading". They do this by selling (buying) a derivative to a client at a price higher (lower) than what it will cost to hedge. So if you're going to include the clients in the world you're considering then obviously it's going to be zero-sum, but if you're just looking at the IBs it's far from zero-sum.

9/15/11

Hmm seemed like the discussion had turned towards zero sum games in general.

Well thats quite obvious. They are market makers for a lot of products so obviously they should be making money for providing this service. Considering the booming demand from market participants (hedge funds are the most cited culprit) banks have been seeing the cash register ring for various market making various products.

9/15/11

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