A zero-sum game is a competitive scenario where one side’s gain is equal to the other side’s loss. In algorithmic trading, for example, if one investor makes a profit, does that always mean that other investors will lose money?
Is Stock Investing a Zero-Sum Game?
Before we get to the key question, let’s take a look at general stock investing with a hypothetical scenario.
Five investors A, B, C, D, and E pooled their capital to start an ALGOTRADE company, with an initial capital of 100 billion VND. Each invested 20 billion VND and owned 20% of the company’s shares.
Three days later, A decided to sell all his shares to G. A agreed to sell at a loss for just 18 billion VND to speed up the process.
A few days later, G found H, who was optimistic about ALGOTRADE’s potential, and offered to pay 23 billion VND for all 20%, and G agreed to sell.
In just a short term, nothing special happened in the business and the total value of ALGOTRADE remained at 100 billion VND. G made a short-term profit of 5 billion VND, while A lost 2 billion and H lost another 3 billion due to paying 23 billion VND for an asset worth 20 billion VND only. The sum of all six investors was zero.
Two years later, ALGOTRADE prospered and the company’s value increased 150% to 150 billion VND. The share price of the investors thus rose accordingly.
The cash flows of all six investors over these two years were as follows:
After two years, the total net benefit of all six investors was 50 billion VND, even though A still lost 2 billion VND.
If there are no major events in the short term like war, natural disasters, etc., the core value of a business hardly changes in a few days. Buying and selling stocks for short-term gains can be seen as a zero-sum game.
In the long term, if there are macro and micro events directly affecting the business fundamentals, the total welfare of the inventors will be either greater or lower than zero depending on the events. In other words, investing in stocks over the long term is a non-zero-sum game.
From a positive perspective, the profits of publicly listed companies tend to grow over time along with general macroeconomic growth. Investors will share the good performance of the business - a game with a sum greater than zero where everyone wins.
Is Derivatives Trading a Zero-Sum Game?
Ignoring taxes and fees, VN30F futures trading is a zero-sum game because all of the trading cash flow is not put into businesses, only transferred from losers to winners. In fact, if all fees and taxes are included, it results in a negative-sum game.
Is Algorithmic Trading a Zero-Sum Game?
Whether algorithmic trading is a zero-sum game depends on the strategy used. Some strategies are based on short-term movements like scalping and day trading. These are prime examples of a zero-sum game. In the long term, without a clear alpha, these strategies will lose money because of taxes, fees, and price slippage.
Most other investment strategies have a positive sum, where the total benefit is greater than zero. A good example is long-term investing using algorithms that expect to profit from the overall growth of the economy. This is a positive-sum game, where everyone wins in the long run.
Moreover, when the market is inefficient, information is not updated fully, quickly, and transparently, and the process of evaluating and analyzing information becomes inaccurate. The process of making investment decisions becomes inefficient. As a result, the stock price deviates significantly from its true value. It results in huge wins and heavy losses. It’s also a zero-sum game but with a wide gap between winners and losers. This can have negative consequences for the overall stock market and the economy: liquidity decreases, good businesses have difficulties raising capital for production and cannot create added value in the long term. Algorithmic trading strategies like arbitrage, market neutral strategy, etc. can help increase the market liquidity and reduce the gap between winners and losers in the short term, making the market more efficient. When the economy grows steadily and sustainably, all investors will win in the long run.
The execution algorithms that reduce trading costs in large-volume transactions are also not part of the zero-sum game.
Especially, the market-making algorithms help increase liquidity, match trading orders, and also contribute greatly to the development of the general market.
In conclusion, an investor’s approach will decide whether they are participating in a zero-sum game or not. Certainly, positive-sum games are always beneficial for investors in the long run.