Saturday, August 8, 2009


A zero-sum game is one where gains and losses balance. You can only win if someone else loses. Stock trading is basically a zero-sum gain. If you have an edge (such as inside information) that allows you to make profitable trades your gains are someone else's losses. Your trades may also make stock prices more accurate but this does not on balance benefit the other participants as is sometimes claimed.

For example Felix Salmon claims here that:

What happens when companies engage in fraudulent activity? Short-sellers get wind of it, and, by selling the stock of the company in question, depress the share price and save uninformed investors some of the loss they would otherwise have suffered had they bought in at an undepressed level. ...

But this is wrong. By depressing the price short-sellers attract additional naive buyers (and holders) since the stock appears to be a bargain to investors unaware of the fraud. So each holder of the stock when the fraud is revealed will lose less but there will be more of them. Additionally uninformed sellers will not get as good a price. The net effect is that the other investors will lose the same amount that the short-sellers gain. So short-sellers (like inside traders) are not doing less informed investors any favors.


  1. Yes but wouldn't we rather punish the uninformed and reward the informed than vice versa, to encourage the seeking of information so that, e.g., further instances of fraud might be uncovered?

  2. I think short-selling should be allowed but it overstates the case to claim it benefits uniformed participants in the market.