Traders often talk about zero sum games. This
discussion came from a branch of game theory which deals with the decision
making process. Game theory is not simply the study of games. It is the
study of how many different and complex problems may have simple
solutions. Game theory helps determine the proper decisions.
Successful trading is highly dependent on
proper decision making. Game theory may be helpful in understanding some
of the decisions required in trading.
A zero-sum game is a game where the amount lost
by one or more players is equal to the amount gained by the other players.
Chess is a two person zero-sum game. If one player wins, the other player
loses. If there is a draw neither player gains or loses. Poker is an
example of a two or greater person zero-sum game. If there are more than 2
players, then one or more of the players can win at the expense of the
other players. However, all players can not win because at least one
player must provide the profits and therefore at least one player must
The stock market is a nonzero-sum game. For
example, I buy IBM for $75. I sell it a week latter for $85 to Stock
Buyer-2. Stock Buyer-2 sells the same stock a week latter for $95. I made
money and Stock Buyer-2 made money. No one lost money. This same
process can yield losses when for everyone when stock prices declines. If
I buy IBM at $95 and sell it to Stock Buyer-2 for $85 and Stock Buyer-2
sells IBM for $75, then we both have a loss. Everyone lost money.
To complicate the discussion, it is possible to
have a negative –sum situation. Commissions and overhead and other
expenses must be considered in the real world. Unless the profits exceed
the expenses, the result is a loss.