Tuesday, May 31, 2011

Is it a Zero-Sum Game?

Hey there

So exams are seriously getting close now. My first paper is in 20 days, which is not very long considering how much I have to study and how many assignments I have to complete.

About a week ago I received an email from a fellow trader that is a lot more experienced than I am and he pointed out a few interesting things that I thought I should share.

The email was in response to my post on bubbles and to summarize it, he put greed and overuse of leverage as one of the causes of bubbles. Most traders would have watched the movie Wall Street. Along with: Goodfellas, Barbarians at the Gate, Citizen Kane, Boiler Room, Wall Street is definitely one of my favourite business movies.

If you’ve watched Wall Street, I’m sure you are familiar with the character Gordon Gekko. In that movie, he was one of the greatest traders, known for his savage I-dont-care-what-happens-to-you-as-long-as-I-make-a-profit mentality. He shows Bud Fox, played by Charlie Sheen before he became crazy, the ways of trading and how to gain insider information. There is a few great moments in the movie when Gordon utters an amazing speech about how greed is good and trading is a zero-sum game.

So what is a zero-sum game? Basically, if I make a profit, someone else makes a loss. If I make a loss, someone else makes a profit and the nett result is zero. Wealth is not created it was merely transferred. So better transferred to me than to someone else. He emphasized that if you are not careful, someone is always ready to take your money.

Thats how I’ve been thinking about the markets for years. I always thought of it as a zero-sum game. There is always somebody on the other side of the deal and if you are making a profit, he is making a loss. However, that email said something else that makes a lot of sense as well. He said to think of it as a minus sum game because we have to factor in brokerage costs and other fees as well.

It was a glass shattering moment for me. DUH... Oh course.... How can you forget to factor in brokerage, account keeping fees, research cost, charting softwares and if you are like me, a lot of books and magazines into this zero-sum game theory.

A zero-sum games implies that as long as you make a profit, its fine. But a minus-sum game implies that you not only have to be in the right position, that correct position must be big enough to cover your other costs as well. So remember to bear that in mind!

So have you heard of this zero-sum game theory? What do you think about it? Is it valid? Or is the markets more of a minus sum game? Or you have heard of another theory altogether?

Do send me emails or drop comments. I really do appreciate them and it really aids with the learning curve. Thanks for reading! Remember to like the page on facebook if you like this site!

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  1. So basically, split your portfolio between brokerages, publishing companies and stock-market software firms. Its a shame that law firms aren't listable as they're a classic example of a business model that profits from process.

  2. Yeah true, does not matter if people are starting a company and closing one, lawyers are always there to charge for their services.

    I didnt realize they are not listable.

    Isnt Slater and Gordon on the ASX?
    check out SGH