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In the stock market, over both the short and long-term, does someone necessary need to lose in order for someone else to make a profit? If not, then more fundamentally does something — in the most abstract sense — need to lose value in order for another's investments to gain value?

Is the stock market a zero-sum game?

Note: Thus far I've received a few answers basically explaining that companies can increase in value spontaneously from increased consumer confidence, but in a far broader sense doesn't this result in decreases elsewhere in the system? I'm really looking for a technical explanation of why the stock market is or isn't a zero-sum game.

closed as off-topic by quid, Dheer, Victor, mhoran_psprep, Nathan L Nov 22 '16 at 14:45

This question appears to be off-topic. The users who voted to close gave this specific reason:

  • "Questions on economics are off-topic unless they relate directly to personal finance." – quid, Victor, mhoran_psprep
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    In the most abstract way the universe is losing 'value' by increasing entropy. But part of the value would be lost nonetheless - If I put solar panels as part of enterprise (and other people would hold shares) as the solar energy is converted to electricity. However (to first order approximation) the solar power would be lost anyway so nothing looses value. – Maciej Piechotka Nov 21 '16 at 22:25
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    No, stock market is not zero-sum because when IBM goes up by $1/share, that additional value came from economic growth, not because someone else out there lost that same amount of money. Options, on the other hand, ARE a zero sum game because when you make $1 in options trading, someone else lost that same $1. – Rocky Nov 21 '16 at 23:37
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    My answer doesn't say anything about companies increasing in value because of consumer confidence. It says that companies make money because customers spend money on their product. – Paulpro Nov 21 '16 at 23:43
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    If Pepsi goes up by converting Coke drinkers, it's a zero sum game. If Pepsi goes up by converting tapwater drinkers, the total market of fizzy sugar drinks has increased (unless you are accounting for reduced revenue at a municipal utility). What are the boundaries of the system you're drawing? Are you worried about mom-and-pop shops shut down by Walmart? Grow-your-own-seed farmers who decide to buy from Pioneer Hi-Bred? – user662852 Nov 22 '16 at 1:07
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    Is it true that 90% of investors lose their money? Is the question I believe identical. I've reversed my vote to close, and will let other members decide. – JoeTaxpayer Nov 22 '16 at 3:20
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No, the stock market and investing in general is not a zero sum game. Some types of trades are zero sum because of the nature of the trade.

But someone isn't necessarily losing when you gain in the sale of a stock or other security.

I'm not going to type out a technical thesis for your question. But the main failure of the idea that investing is zero sum is the fact the a company does not participate in the transacting of its stock in the secondary market nor does it set the price.

  • XYZ Company has a new stock issue.
  • Bob and other investors buy the shares from XYZ Company. The company receives the proceeds.
  • Bob sells his shares in XYZ Company to Jenny. Bob receives the proceeds.
  • Jenny is not at a loss because she received the shares.

This is materially different from the trading of options contracts. Options contracts are the trading of risk, one side of the contract wins and one side of the contract loses.

If you want to run down the economic theory that if Jenny bought her shares from Bob someone else is missing out on Jenny's money you're free to do that. But that would mean that literally every transaction in the entire economy is part of a zero sum game (and really misses the definition of zero sum game).

Poker is a zero sum game. All players bet in to the game in equal amounts, one player takes all the money. And hell, I've played poker and lost but still sometimes feel that received value in the form of entertainment.

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    Not necessarily. Industries can grow as a whole. How about the fact that money only has value because everyone believes it has value? That'll really cook your noodle if you think about it too much. – Rocky Nov 21 '16 at 23:38
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    @TheEnvironmentalist No, an employee needs to provide more value to a company than he costs the company in compensation. Otherwise, why would the company hire him, if they are gaining nothing from the arrangement? – Ben Miller Nov 22 '16 at 3:06
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    @TheEnvironmentalist As a simple example: a web development firm might have customers that pay them $200/hr and they might hire web developers and pay them $50/hr. The company benefits because it makes $150 for each hour that its web developers work, but the employees also benefit because the company is well-established, has regular customers, and has other employees helping grow the company and finding new customers. The employee, on their own with no company, might not be able to get steady work at $40/hr and would have to spend much of their time trying to find clients. – Paulpro Nov 22 '16 at 3:27
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    @TheEnvironmentalist Also when you buy a banana in the supermarket you probably are happy to pay more than a banana is worth. You are probably happy also paying for some of the gas for the vehicle that transported the banana to the store and for the store employees wages and for the profit margin for the store (which is what motivates the store owner to run a store in the first place). All of those things are factored into the price that the store is willing to sell a banana for, but are not part of the value of a banana. – Paulpro Nov 22 '16 at 8:44
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    @TheEnvironmentalist: OK, say I bought shares of Intel in 1980, just before the IBM PC was introduced, and held them until today. Intel stock is worth many times more than it was then (not even counting the dividends), because Intel has sold, and continues to sell, a lot more computer chips. Very little of that added value came at the expense of the makers of mechanical typewriters & adding machines :-) – jamesqf Nov 22 '16 at 18:52
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Would you mind adding where that additional value comes from, if not from the losses of other investors?

You asked this in a comment, but it seems to be the key to the confusion.

Corporations generate money (profits, paid as dividends) from sales. Sales trade products for money. The creation of the product creates value. A car is worth more than General Motors pays for its components and inputs, even including labor and overhead as inputs. That's what profit is: added value. The dividend is the return that the stock owner gets for owning the stock.

This can be a bit confusing in the sense that some stocks don't pay dividends. The theory is that the stock price is still based on the future dividends (or the liquidation price, which you could also consider a type of dividend). But the current price is mostly based on the likelihood that the stock price will increase rather than any expected dividends during ownership of the stock.

A comment calls out the example of Berkshire Hathaway. Berkshire Hathaway is a weird case. It operates more like a mutual fund than a company. As such, investors prefer that it reinvest its money rather than pay a dividend. If investors want money from it, they sell shares to other investors. But that still isn't really a zero sum game, as the stock increases in value over time.

There are other stocks that don't pay dividends. For example, Digital Equipment Corporation went through its entire existence without ever paying a dividend. It merged with Compaq, paying investors for owning the stock.

Overall, you can see this in that the stock market goes up on average. It might have a few losing years, but pick a long enough time frame, and the market will increase during it. If you sell a stock today, it's because you value the money more than the stock. If it goes up tomorrow, that's the buyer's good luck. If it goes down, the buyer's bad luck. But it shouldn't matter to you. You wanted money for something. You received the money.

The increase in the stock market overall is an increase in value. It is completely unrelated to trading losses. Over time, trading gains outweigh trading losses for investors as a group. Individual investors may depart from that, but the overall gain is added value.

If the only way to make gains in the stock market was for someone else to take a loss, then the stock market wouldn't be able to go up. To view it as a zero sum game, we have to ignore the stocks themselves. Then each transaction is a payment (loss) for one party and a receipt (gain) for the other. But the stocks themselves do have value other than what we pay for them. The net present value of of future payments (dividends, buyouts, etc.) has an intrinsic worth. It's a risky worth. Some stocks will turn out to be worthless, but on average the gains outweigh the losses.

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    That's the answer. It's not a zero-sum game because of dividends. If stocks don't pay dividends, then it is a zero sum game: a game where there the total winnings is the sum of the contributions of the players. – JimmyJames Nov 22 '16 at 15:08
  • I guess the other way is when a company is liquidated and the assets liquidated. This doesn't come up much in public companies except when they are purchased by another company and that usually results in stock conversions. – JimmyJames Nov 22 '16 at 15:18
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    Stocks that do not pay dividends are, in fact, a zero sum game. It's "just that simple". Every single dollar in the game (for that stock), comes from, the players. End of story. – Fattie Nov 22 '16 at 16:29
  • "an increase in value..." note though that "value" is just a term. Regarding US Dollars, and regarding a stock that does not pay dividends, it's a straightforward "zero sum game" amongst a certain set of players. (Note that the number of players may be increasing over time, but it's a zero sum game amongst all the players of that given stock, as simple as that.) – Fattie Nov 22 '16 at 16:31
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    Jimmy, Berkshire Hathaway doesn't pay dividends. Does that make its stick a simple zero sum? Money pours into that company faster than you can count . – JoeTaxpayer Nov 22 '16 at 18:48
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No.

Share are equity in companies that usually have revenue streams and/or potential for creating them. That revenue can be used to pay out dividends to the shareholders or to grow the company and increase its value.

Most companies get their revenue from their customers, and customers rarely give their money to a company without getting some good or service in exchange.

  • The vast majority of stocks pay no dividends. A given stock (that pays no dividends) is simply a zero sum game. It's worth noting that even if a stock X DOES pay dividends, the total "game" of all the stock X transactions, as such, are indeed a zero sum game for that stock X, just as for any normal (ie, non-dividend-paying) stock. Sure, there are extraneous benefits/expenses to "taking part in the game of" a certain stock X. (Cost of brokerage, electricity to use a computer, dividends, tax issues, etc etc etc.) But literally the stock is of course a "zero sum game". – Fattie Nov 22 '16 at 16:34
  • @JoeBlow A company that isn't paying dividends can still have positive net revenue, and most companies do. Your comment is like saying that starting a business, that you own 100% of, is a zero-sum game because when you eventually sell the business someone else has to pay for it. That ignores all the income your business has made while you owned it. – Paulpro Nov 22 '16 at 17:25
  • @JoeBlow Perhaps you bought the business for $1M and then used the business' income to expand it to 9 new locations and bought real estate for an office in each location. When you bought the business it owned 1 office and that was factored into the $1M you paid for it. Now it owns 10 offices and also has the potential to make 10x as much income. It is definitely worth more now, but no transactions have taken place. The 10 offices alone are probably worth more than the $1M you paid for the business. – Paulpro Nov 22 '16 at 17:34
  • Also if a company is paying dividends and you keep their stock for a while you will eventually get your entire investment back, just from the dividends, but you will still own the shares and still be earning more from dividends. That seems like the opposite of zero-sum to me. – Paulpro Nov 22 '16 at 17:37
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    As for #2. You think that StarBucks has the same intrinsic value today with over 15000 locations as it did when it had 3500 locations in the year 2000 or even when it was a single coffee shop in Seattle in 1971. That's hilarious. – Paulpro Mar 29 at 16:19
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While this seems overall a macroeconomics question and not really personal finance, let me give it a shot:

The question of why corporations form in a free or efficient market is why Ronald Coase received the 1991 Nobel Prize in Economics, for his work developing the theory of the firm

Corporations organize when there are transaction costs in the free market; corporations form when it is in fact more efficient for a corporation to exist than a number of small producers contracting with one another. To the extent that corporations add efficiency to a total market, they are not "zero sum" at all; the net production is increased over what would exist in a market of sole proprietors who would have costs (such as researching the trust levels in counterparts, regulatory compliance, etc) that they cannot bear to engage in the same level of transactions.

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Suppose everybody stopped all economic activity right now. No more work for others, no payments, no trade in kind or otherwise.

Would average wealth stay the same? Of course not. Economic activity is not a zero sum game.

Most of our economic activity is organized in the form of companies. If the companies manage to make more profits by doing useful things more efficiently, or when they find new useful things to do for profit, then not only the company's value grows but also the sum total of all useful things produced in the economy. That means it's not zero sum.

When stock prices go up, that is often because the companies really have become more valueable.

  • But note that the question is not about "wealth" or "economic progress". A given stock X is simply a zero sum game. "When a stock price goes up..." all that literally means is that: some person P gave you some money. Selling your stock to person P is no different than selling your fridge or car to person P. "A stock price going up" means some person P gave you some money; that number was higher than when you gave some other person O some money for the share in question. – Fattie Nov 22 '16 at 16:38
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    At the moment you trade, the stock's value is presumably exactly that money amount, nobody gains or loses. The interesting part is where the stock's value goes up or down over time, that's a company's total value changing over time. No reason why that would be zero sum. – RemcoGerlich Nov 22 '16 at 21:55

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