Wednesday, June 5, 2013

Stock Market, Zero-Sum Mentality

A zero-sum mentality is one that believes that there is a winner for every loser and visa a versa. When I say the stock market is not zero-sum, I that mean the winners do not necessarily equal the losers. Basically everyone can win when the total value of the market goes up and everyone can lose when the total value does down. If you think of the market as a pie, it is a pie that can get bigger or smaller.

When the stock market expands not everyone is a winner, it is just easier to be a winner. There are always stocks that do not go up when the general market does. Just as when the market contracts, it is harder to be a winner, but some stocks do go against the trend.

In the western world, the stock markets have tended to expand over the long term. So, it is easier to be a winner in stocks over the long term. What kills stock markets is when a country goes bankrupt. Wars are also not good for a stock market, especially if the economy gets badly damaged.

When the markets go up, no one asks where the money was coming from to power the rise. However, when they come down, everyone wants to know where THEIR money went to. I see this happening all the time. People just have no understanding on how the stock market works. There are also relative winners and losers because people buy and sell stocks all the time.

When the markets go down, you really only lose when you sell or the company goes bankrupt. Whether you should sell or not can be tricky. If your stock goes down just because the market has gone down, there is usually no need to sell. If this is not the cause, look to see if it is just a temporary setback. The stock market has a tendency to over react.

If a stock has something negative happening, like the EPS is not what was expected, the market can react harshly. This might only be temporary. This can lead to a special buying situation where you can make good money. If revenue and EPS are down and the debt ratio is high, you might want to reconsider if you want to hold on to a stock. Some stocks never recover and some take a very long time.

The economy is not a zero-sum either. An economy can contract or expand. That is the economic pie can grow bigger or smaller. When it goes bigger everyone can be a winner and when it contracts, everyone can be a loser. Although, this is generally not what happens here either as there can be winners and losers on both the expansion and contractions of the economy.

However, option trading is zero-sum. Here you are buying and selling by contract. For every winner there is a loser. I understand option trading, but I do not do it. I do know people who have quite successfully made money trading options.

This blog is meant for educational purposes only, and is not to provide investment advice. Before making any investment decision, you should always do your own research or consult an investment professional. See my site for an index to these blog entries and for stocks followed. Follow me on Twitter.

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