Wednesday, October 26, 2011

Trading is a zero-sum game? Bullshit!!!

Have you ever heard this before?  "Trading is a zero-sum game!"

This is a statement that is in most beginner "learn how to trade" books, and its bogus!  If you haven't heard it, the basic premise, is that for every buyer that takes a trade there is a seller, and vise versa..... so when you make a trade someone is taking the other side of it, so in every trade there is a winner and a loser.  The winner being the person who called the right direction, and bought when prices moved up, and the loser of this would be the guy who sold to him....  this implies that you are only buying and selling from one person!!! 

The intention of the statement is to think that if you're buying and someone is willing to sell to you, then what is it that the other person knows that you don't know.... and what if the person taking the other side of your trade is a trader at a bank who obviously has access to better and faster info than you sitting at home and putting on a trade through the internet.  And why is it that you think you're out smarting the other person who obviously just took the opposite side of your trade!!!! 

The statement makes sense to a beginner trader, because it seems logical, if I buy then someone else is selling to me.... so he must be taking the OPPOSITE side of my trade... and if I WIN, then he must LOSE!

This idea is NOT true.... someone IS taking the opposite side of your trade, but only at that moment.  Think about it like this.... Google (GOOG) IPOs at $100 and starts trading, and for simplicity assume that there are NO short sellers, you can either buy new shares or sell your already existing shares.  Buyers come in and bid $100.50/share, the sellers are the founders of Google, bankers who own shares as part of the IPO and other similar parties..... if they are satisfied with $100.50/shr then they will sell to the buyer.  Now the price of GOOG is $101.50... now comes along another buyer who is willing to buy at $101/shr because he thinks GOOG will go to $120 and bids $101.00/shr, now if the founders OR the guy who bought at $100.50/shr want to sell at a higher price they can do so because there is a buyer..... And so on the price moves up.

Look at the transactions above, THERE ARE NO LOSERS!!  Everyone has made money and the guy who bought at $101.00/shr is neutral on his position.  So even though trades were made, there were NO losers!!!
The person who took the other side of your trade wasn't a banker with more info who KNEW you were being suckered at $100.50, but perhaps a founder who wanted to sell out of his shares fast.... yet he still made money!

Now you're saying well prices can't go up forever, so there has to be a loser..... well you're right!  Let's say that through many trades the price of GOOG was bid up to $400, where someone just bought some shares at $400, but some unfavorable news came out and people who owned shares got scared, now there are no bids above $400, but there is someone who would buy GOOG at $395, so one of the founders sells to this bidder for $395/shr....... now the price is $395/shr.   Even here everyone who has bought below $395/shr has been a winner and continues to be a winner, but everyone who bought higher than $395/shr has now instantly become a loser!! BUT this is only a select group of late buyers!

So the statement that trading is a zero-sum game and that for every winner there is a loser who took the opposite trade is BOGUS!!!   Do NOT think of trading in that way!  Many buyers and sellers come to the market , some are buying for the long-term, and some buying for the short-term... some are selling out of their positions while others are buying their shares, anticipating more future upside... and so goes the market!