Stock Market EV

[hmkpoker]

How is investing in the stock market +EV? I view the following as true (please correct me if I'm wrong):

1) The market is an almost-zero-sum game. Corporate earnings influence the values of stocks (which hurt or help everyone alike), but because most stocks have phenomenally high P/E ratios, the market is essentially zero sum.

2) Because it is zero-sum, you are competing against others in a game of odds. This includes people who have inside information, and therefore have a better edge of when to buy and sell. (I figure this would be like playing poker with people who are much better than you...and the broker's fees are like a rake!)

So how can stock trading be +EV?

Your first assumption is wrong. The market is a positive-sum game. Corporate earnings will continue to increase over time (or at least they have for the past 400 years) at a rate of around 10% per year. This will eventually be reflected in share prices and dividends.

Based on PE ratios, you may think that stock prices won't reflect increased earnings in the middle term, but this is hardly ironclad. It's just as probable that PE ratios will remain constant, meaning increased earnings will cause increased share prices. Over a 20 or 30 year horizon, you can be fairly certain that the market as a whole will beat inflation and short-term interest rates.

[Sniper]

You really should read thru other recent posts... this forum does not get too much traffic to make this impossible to do.

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1) The market is an almost-zero-sum game.

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No it is not... the stock market is in no way a zero sum game!

Very simple example... 4 players...
Player A has $10, Player B has $10, Player C has $10, Player D has $36, Total wealth in system = 10+10+10+36= 66

Players A,B and C all buy 1 share of stock for $10.
Then Player D buys 1 share of stock from Player A for $11, 1 share of stock from player B for $12, and 1 share of stock from Player C for $13...

Now... player A has $11, Player B has $12, Player C has $13, and Player D has 3 shares of stock worth $39, Total wealth in system = 11+12+13+39 = 75

Note that Everyone is ahead... Player A +1, Player B +2, Player C +3, Player D +3.

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So how can stock trading be +EV?

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Because someone who knows nothing about investing can stick their money in an index fund and earn roughly +10%/yr compounded. In the stock market ALL players can be big winners.

ok... so how is this possible... several reasons, but the easiest way to understand this might be, because the true value of a stock is based on factors outside the stock market system.

A comparison to poker would be if the value of the chips on the table increased while you were playing and you could cash in your $25 chip for $50 cash.

[hmkpoker]

(I'm sorry that this is such a dumb question!)

Why does Player D have 3 shares worth $39? (Presumably at $13/share)

If this is the case, haven't players A, B and C all earned +$3, since the value of their stock is now $13?

[Sniper]

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Why does Player D have 3 shares worth $39? (Presumably at $13/share)

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The value of a share is generally qouted as last trade value. (yes 13x3=39, sry if that wasn't clear)

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If this is the case, haven't players A, B and C all earned +$3, since the value of their stock is now $13?

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Because Player D bought Player A,B& C's shares...
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Then Player D buys 1 share of stock from Player A for $11, 1 share of stock from player B for $12, and 1 share of stock from Player C for $13...

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[hmkpoker]

This seems really, really wrong.

If it's correct, then why can't four people assemble in a like fashion and make tons of money?

[Unabridged]

the market isn't zero sum because its a pyramid scheme. always fresh cash entering the market, just like poker

[hmkpoker]

money is being withdrawn too.

I usually post in the MTT forums cause that's what I play as a hobby, but I thought I might as well post here after reading this post.

A quick background. I am a day and swing trader, I have made my living for the past 4 years doing so.

Anyways, to the question. If you have read Alexander Elder's books, he has an entire chapter on this. The Stock Market is not a Zero-Sum game, it is less than that. Brokerage commissions and SEC fees make it a losing venture unless you have an edge. This is why most traders lose. My first 9 months of trading was very difficult because I was paying my "trader's tuition" as Elder calls it. I was learning by losing. You are taking into account the fundamental aspect of the market which is, in my and many trader's opinions, irrelevant. For example, Qualcomm (QCOM) has a track record of beating the street and reporting phenomenal earnings. One earnings release QCOM beat by 15% but despite these huge numbers the stock dropped 6%. The market is based on psychology and this psychology is reflected in the charts. In the extreme long run inflation increases and the market goes up and investors seem to make money. However the Real Return (inflation adjusted return) is around flat. Therefore, (successful) traders have an enormous advantage over investors.

Another thing, your average 40-something investor who invests for retirement is putting money in stocks which he things will increase in value. Uninformed people like this don't realize that stocks include intrinsic future value. Lets say you buy Google (GOOG) because you think it has huge potential. Well guess what, so does everyone else. This potential "potential" is already factored into the stock price. Same goes for the earnings in the QCOM example earlier.

Just my 2¢

-Chris

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However the Real Return (inflation adjusted return) is around flat.

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No. Look at Figure 3 on this page. Stocks outpaced inflation by 5.5% in the last 100 years in the UK. It was 6.9% in the US between 1926 and 2001. This is based on an increase in intrinsic value following expanding businesses and growing profits.

Good luck with the trading. Have you stopped paying tuition yet?