Jan 14, 2007
Originally Posted by Nerva
I've heard various sources from other forums and publications differ as to whether Forex is actually a zero-sum game. (i.e., if you win, someone else loses) Here are some arguments for and against that assumption:
Forex is a Zero-Sum Game:
-Each position you hold, long or short, there will be someone else on the other end who will be losing money if it goes in the direction you want. (think about the mechanics of exchaning the money and variable rates)
-Forex is often lumped in with futures, etc. as a risky market.
Forex Is Not a Zero-Sum Game: (my position, although I think in some ways it is a zero-sum game)
-The market moves based on psychological and fundemental underpinnings.
-Not all speculation in the market (exchanging of currencies) is based on profiting. (businesses, individuals, etc. can also trade one currency for another)
-Market price is based more on the enthusiasm of buyers and sellers, and not just the underlying mechanics of the exchange rate. (just as in the stock market the price may have little correlation to the actual value of the firm.)
What are your thoughts? I think in some cases there are points when banks and institutions can throw their weight around to take out stops, but overall, one institution cannot just "gobble up" a small fish. Why? Market price is driven primarily by the enthusiasm and psychology of millions of instititions, traders, and currency exchangers - all creating price patterns which can be used to make a profit.
I think it's important to clear these issues up in order to better grasp the dynamics of the market.
This question seems to come up every couple months...
Want to understand a zero sum game? Consider what would happen if every man woman and child on the planet suddenly wanted (for whatever reason) to get out of their asset positions at the same time. If the value of the asset would drop to zero, you are in a zero sum game.
Forex, the stock market, and even the real estate markets are all zero sum games regardless of what you read in the promotional materials.
Originally Posted by merlin
i beg to differ dark. the stock market is not zero sum. the company stock can rise, making everyone's shares worth more, even though no exchange (trade) has taken place.
How does that happen exactly? Not being argumentative, I'm actually very curious...
Originally Posted by Tesla
Being an ex-stockbroker, maybe I can field this one...
I'm guessing you're used to forex and commodities, where when you take a position you're really entering into a contract with a counterparty which either gives you rights or responsibilities or both. If I buy a put option on cattle, I've got a right to do something and the person on the other end of the trade received monies in exchange for agreeing to let me do it. Same thing with forex. As the value of the rights and responsibilities fluctuate, the value of the contract or position does as well.
Stocks (and most items of value like realestate) work a bit differently. It's usually not an ongoing relationship with a counterparty (though it can be with shorting and options).
Example scenario: Gene Splicer Inc. is a publicly traded company which discovers a drug that cures 99% of all cancers. The stock jumps immediately to a billion dollars a share. Who's lost money? Remember that there's not someone short one share for everone long one share.
Here's another bit of trivia... you can draft up a contract for put and call options on a house. If you do so, any further fluctuation in the perceived value of the property is a net zero gain since someone gains and someone loses.
Hope this makes sense, trying to get it all posted before I crash for the night.
Ok. I understand what your saying but I have to disagree. The argument for stocks and even real-estate being positive sum fails to account for any indirect costs of market price movement.
Try this example: I open up Darkstar’s Lint Manufactures and list it on the stock exchange. As a manufacturer of lint, I have earnings of $100/yr (there is always a sucker somewhere). I own 100% of the 100 shares of stock (just follow along…). How is price discovered for the value of my stock? We could look at the market multiple, or the sector multiple and come up with a value, but how does that money actually get in my pocket?
Let’s say I want to use a multiple of 15X to value each share at $15. To get this value, I have to sell the stock to someone who agrees with my valuation. Since we have such low earnings and a shitty product, let’s assume there is only 1 other person in the whole world interested in purchasing my stock. If they value my shares at a 10X multiple, I can only receive $10 per share regardless what I think its worth. My choices are to accept the buyer’s valuation, or hope that I can find someone else to value my shares higher. Until I find someone else, my shares have an effective value of $10.
Taking all of the above into account, let’s say I release an earnings report showing an increase to $200/yr. I can now justify $30 a share to myself and anyone who will listen, but the only interested buyer for my stock can argue that my company has oversold the market and earnings may drop dramatically next year. He now only wants to value my shares at a 5x multiple. In this scenario, even with a phenomenal earnings report, the value of my shares has not changed. They are still only capable of being converted into $10 per share.
This is all pretty basic. The part that screws everyone up is when we examine the indirect costs of price movement. Going back to the pre-earnings report $100/yr figures, let’s examine how each party benefits and loses as a result of post-report price movement.
The potential buyer for my stock wants to buy my stock. Without him, my stock has zero value. We should never forget this. Prior to the report, this potential buyer has the opportunity to buy my stock at $15/share, but is only willing to pay $10. Let’s assume the earnings come in at $1000/yr. Even with a 10x multiple, each share is now worth $100 to the buyer. If the buyer decides to pay this rate, the profit that would accrue to me as a result had nothing to do with the report. The buyer has changed his opinion about how to value my shares. As was pointed out above, if he does not alter his opinion in a way that alters a shares value, the report is irrelevant. The $90 extra per share that the buyer decides to pay post-report is where my profit came from. It was the buyers indirect opportunity cost that I benefited from. If he had decided to buy my shares at $15 pre-report, the new valuation would have accrued to him instead of me. In short, my benefit could not have been possible without his loss.
You can swap in around too. Say the report came out at $10/yr in earnings. The $9/share I lost was paid to the potential buyer in cost savings. My opportunity cost for not selling was his savings gain. Zero sum.
No matter how you slice it you cannot escape the fact that without an agreement to transact, a security has no value. If every man, woman, and child on the earth suddenly decided that owning stock would cause them to die in 1 minute, every share on every exchange would instantly be valued at $0. Unless or until you can resolve that problem, you are participating in a zero sum game.