Is Stock Market a Zero-Sum Game?

Many people think of the stock market as a zero-sum game. But whether it is really a Zero-sum game, or just a scheme adopted to justify the stock market losses and keep retail investors out of investing. We will understand. 

First, let us gain more clarity for what is a “Zero – Sum Game”. A zero-sum game is one in which no wealth is created or destroyed. So, in a two-player zero-sum game, whatever one player wins, the other loses. In a zero-sum game, gains for one person causes losses for another person in an identical amount. The net change for everyone involved is zero and no wealth is created or destroyed during the transaction. 

A simple example of such a Zero-Sum game can be a Game of chess or Rock, Paper Scissors where the win for one person means a loss to others. On a practical front, or where actual monetary transactions are involved simple gambling or a betting game is an example of a Zero-Sum game, where the winner will win an equal amount than the loser of the bet will lose. These all are examples of the Two-Player Zero-Sum game. 

But there is a multiplayer zero-sum game as well, where the net loss of all losers is what the total gaining of the winners are. In a bet or a gamble game involving 10 people, the total gains made by the winner/winners will be equal to the total money lost by losers. A number of sports fantasy games too that are emerging in recent times are zero-sum game (neglecting the platform fees and commission), as no actual wealth is created in any of these cases. 

The stock market is most often confused with a multi-player Zero Sum game, as there are numerous players in the market and it is assumed that what other people will lose is what others will gain. But this is not the case. The Stock in the long run is not a Zero-Sum game and there is real and actual wealth creation in the stock market. 

In long run, to better future prospects, increasing business potential and overall economic growth, the overall market value increase of all the company and stock market is not a zero-sum game. The stock market is a place for investment into businesses and businesses grow and expand and with growth and the increased output of the businesses, the profitability and future prospects of the businesses improve. 

This translates to an increase in the valuation of the companies and businesses, which lead to actual value creation and wealth addition in the stock market. When you buy a share of stock, you are actually acquiring a percentage of equity in a certain company and as the part ownership of businesses of higher value due to improved growth, this converts into actual wealth creation in the stock market, which has increased in value due to better future prospects, and people in long turn gain more than loss by other as there is an actual increase in valuation levels. 

For Example, NIFTY at the start of 2010, was close to 5000 levels. Which by the start of 2020 has crossed 12,000 levels as level. An increase of 2.4x times in 10 years. The story of many individual stocks is much more promising. This increase in the Level of NIFTY, or any other stock, leads to actual wealth creation, and people do make actual gains and gains and lot always supported by loss made by other people. 

In the share market, trades are based on future expectations and because of the different risk tolerances of the participants. Someone selling their stock doesn’t mean they are losing. They might have made substantial profits and willing to book profits. And similarly, if one sells, there’s no reason to think that the next investor can’t profit too. Here, both the parties can be winners, as the buyer of the stock now can further sell at an increased price when shares have made sufficient gain according to that investor. 

Therefore one investor selling shares to others at profit doesn't mean the buyer will incur loss only. Taking a Company-specific example, shares of RIL at the start of this decade (2010) traded around Rs 500 (Factoring the stock splits and bonuses), and a total market valuation of around 3.5 Lakh Crores. The company has now breached even 2300 level and a valuation of over 15 Lakh Crores. 

There have been actual wealth creation of over 10 Lakh Crores and people have gained money without others losing their investment and there has been a net increase in wealth for more than 10 Lakh Crores. Added to this is one important factor that clearly removes every confusion in this regard. That’s Dividend. 

A dividend is an additional amount paid to investors over and above any capital gains made as profit appropriation. Being part-owner of the company, investors are obliged to part of the profit in the firm. As dividend(if paid), doesn’t depend on the loss or profit made on the previous transaction, having a net additional cash flow makes the Stock market a Non – Zero-Sum game as net total inflows are more than Net outflows over the long term. 

Therefore, as we have seen from these examples, unlike a Zero-sum game there is real wealth creation in the stock market due to increased company valuation because of better future prospects and net gains and more than net losses, (If shares price went up for that period of time). So the Stock market is not a Zero-Sum Game.