What is Zero Sum Game?
This is a condition in a game theory where the loss incurred by an individual is equal to the gain of another individual. Therefore, the net change in wealth is equal to zero. A zero-sum game can have as little as two players participating or as many as millions of participants. Futures and options are types of zero-sum games in the trading world, with the exclusion of transaction costs. Like a two-sided coin, for every contract gained, there is an opposite contract loss.
Understanding Zero-Sum Game
Zero-sum games exist in game theory but are not very popular as non-zero-sum games. A famous example of zero-sum games is gambling and casino. Since the total number of wins by a player is equivalent to the total loss of another player.
Also, games like tug of war and badminton are examples of zero-sum games. Since they have a single winner and a single loser.
Is the Stock Market a Zero Sum Game?
The collective performance of traders in the stock market relative to an index is a zero-sum game. This is because the figure of an index contains all wins and losses. It qualifies to be a zero-sum game by definition.
For instance, when looking at market outperformance; for all out performance, there would be a relative underperformance somewhere else.
Although, you must not consider the entirety of the stock market as a zero-sum game. Since it fails to match all the criteria to be an actual game with participants. You can only liken an individual’s performance to the stock market index game.
What is a Non-Zero Game?
This is a condition that involves the existence of net benefit or net loss to the system. This depends on the result of the game. An example of a non-zero game is the Prisoner’s Dilemma. This occurs when you interrogate two prisoners separately and present them with a bargain.
If one of the prisoners confesses, he will be set free while the other would get convicted for 12 years. But if they both confess, they’ll convict each one of them for only 2 years.
Another example is in a trading market, where all competing companies join forces together to extend the entire market size. Establishing a wide market structure would increase confidence in the market and lead to increased profits for all competitors.
It is important to note that a zero-sum game could result in a net negative result. And not necessarily a positive one.
In the example of the prisoners above, if both prisoners were to confess, then it results in a net negative for both parties.
Origin and the Importance of Zero sum Game
The zero-sum idea commenced with the notion that a win could only be possible as a result of the opponent losing.
This belief was possible as a result of erroneous economic understanding and finance. This is where the participated entity was fixed and not changeable. And as such, having the notion that you can only achieve a profit by seeing to the loss of competition.
The modern economy, on the other hand, has brought about more awareness. It makes us realize that not all competitions belong to this category. There is a possibility for all participants to record a win. For instance, considering the classical theory of trade, by Ricardian “All parties involved in trade benefit from it”.
Zero Sum Games vs. Non Zero Sum Games
With a non-zero-sum game, the fate of both sides can go up and come down together. The most ideal form of the non-zero-sum game is a win-win scenario, in which the two sides gain from a deal. For example, when players switch between two sports teams, and each team meets the demand, then the trade gives off a net positive-sum.
A non-zero-sum game, on the other hand, can as well produce a negative effect for the two teams, a lose-lose scenario. For instance, if two sports teams exchanged players but one team’s player got wounded and the second team decides to retire as opposed to accepting the trade, it will result in a lose-lose state.
The net gain will become negative because the two teams have lost something. Zero-sum games usually give a net gain of zero, with a team winning while the other is losing. And non-zero-sum games give a net positive or net loss.
What is Game Theory?
Game theory is a theoretical aspect of learning in the social sciences that adopts a mathematical approach to forecast the possible result of a certain situation. It is usually adopted by people in political science, business, or poker to guess likely results for situations in their area of specialization.
Game theory uses a succession of real-life, calculated conditions through sequential games to forecast decision-making processes.
A zero-sum game is a condition where if one participant loses, the second participant wins, and the net disparity in wealth turns zero. The zero-sum game is the inverse of the win-win condition, in the sense that a transaction agreement massively increases trades among two countries or lose-lose conditions like war.
For example, in the real world, however, things are not very visible always, and profits and losses are usually hard to measure. The majority of transactions and deals are non-zero-sum games because they end up benefitting both parties in the end.
Futures and Options trading is the nearest practical example to a zero-sum game situation since contracts are agreements between two sides. If one side losses, then the other side gains. Even though this is a basic analogy for options and futures, usually if the price of the underlying asset increases (mostly against expected market outcome) within a specified period, a trader can end the futures contract after profit. Meaning, if a trader realizes money from the bet, the other is bound to lose, and the net result is the transfer of money from one trader to another.