Well said. As in some casinos, in the world's stock markets some big players (probably including certain HFTs and hedge funds) take much more of the winnings than small ones, due to information asymmetry or pure competitive advantage (e.g. due to extremely fast trading and advanced algorithms).
The more money is sucked from the market by intelligent arbitrageurs/gamblers, the less there is for small(er) investors. That's a bad thing in itself and also increases the focus on financial gameplay (analysis of market trends and fads) to the detriment of investment (analysis of the worth of companies). Frothy, ever-rising stock markets attract investment away from other markets, usually for poor reasons: the traded companies haven't done anything that would justify such rapid and significant changes in their stock values.
The point of the stock market is not to let the smartest people profit from the rest; it's to allow companies to raise capital efficiently and fairly. If we tweak the rules of the market, by limiting trade frequency for example, we may be able to push the play in the market towards a form that aligns better with this core function of the market.
Finally, I want to reiterate that for a closed population, the stock market is a zero-sum game. Money made is won from someone else, always.
edit: i'd appreciate you mentioning the points you disagree with when you give your downvotes - thanks
I didn't downvote you, but you're wrong for a huge variety of reasons.
Firstly and most importantly, the stock market is not zero-sum.I don't know why you think it is.Equities in companies ideally (and historically) grow in real value.This is basic common sense.If your friend sells you a stake in his company, you have an ad-hoc stock market (a buyer and a seller for company equity). Is one of you destined to lose in this deal? Or can the company do well and you both succeed?
What's going on with HFT is not a novel way to exploit the system. Financial pros will always get the information sooner and be able to act on it more quickly/efficiently than retail investors. People who suggest otherwise are deluding people for political purposes. Before computers existed, people on Wall Street still got the information first and acted on it first.
What computers have done is made the whole thing quicker and more convenient. If you want to fill an order you are much more likely to be able to. Those advanced algorithms help make sure things are correctly priced which is good for buyers and sellers. The companies looking for investment benefit from this. The smaller investors aren't hurt by this at all from this, assuming they are trying to invest in value and not take advantage of arbitrage opportunity.
Contributing liquidity and pricing information to the market is valuable. Some people do it faster and better than others and so they profit from it. It's unclear to me why they need to do a worse job of it so that other people can share in this value. Should Google be limited to only providing so many search results a day so that other small(er) search engines can get some of the wealth too? What exactly is the problem, besides the general popularity of banking fear-mongering recently?
"Firstly and most importantly, the stock market is not zero-sum."
It is, unless you have another definition of zero-sum. The talk about companies "growing in value" ignores the fact that the "value" is purely what the market will pay for those companies. If the market is a closed system, i.e. companies are not being listed or delisted, then the net profit made by buyers & sellers if all transactions were to be closed out is zero, by simple summation. (Actually, it's negative, because of significant transaction fees.)
"If your friend sells you a stake in his company, you have an ad-hoc stock market (a buyer and a seller for company equity). Is one of you destined to lose in this deal? Or can the company do well and you both succeed?"
If the company does well and you sell the stake to a third person (C), then you've profited and C is left holding the bag. Every single trade that is closed out results in either a profit or loss to its participant, and it's only the fact that the more money is put into the stock market over time that obscures the fact that, if all extant trades were to be closed out at one point in time (i.e. everyone cashed out), the net profit of everyone involved would be zero.
The market keeps growing because new money and participants are flowing in, but if this stops (say, due to foreign investors wanting to put their money elsewhere, or a shrinking investor population, or a recession), then all you have is a moribund market into which existing investors dare not put more money. The average profit for trades goes to zero because the average stock price is not moving up or down.
This is practically illustrated whenever a bubble bursts and money leaves the market: many participants start taking the losses that had been hidden by the previously rallying prices. The winners are the ones who got out first and took profits from those inflated prices.
I argued this point with two friends of mine, one who was an investment advisor, and another who was an oil trader. The advisor said that it wasn't zero sum and the market was always expanding, but after a bit of discussion and graph-sketching, he came to see that it was zero-sum after all. The oil trader (a pretty savvy chap) said, "Yeah, that's obvious. That's the game I play every day."
(I think this can be extended further to encompass the various financial markets as alternative sectors of a giant investment market offering various classes of product. In the end, each market is zero-sum, and so the overall investment market is zero-sum, which is obscured by the increase in production as technology advances. But this part is more speculative so I won't push it.)
I'm a bit occupied atm so I'll reply to the rest of your message if there's still interest later.
No, your friend is not left holding the bag. He's left holding the money you paid him for the equity. You were the one in the red at first, but since the value of your stake could grow and pay you in dividends you overcame that loss. Both of you gained money - that's the point. He didn't even lose the opportunity for more money, because he needed the initial investment to even grow the company in the first place.
Here's the key point you're missing. In order for it to be zero sum, if you make a million dollars off of this company, he needs to LOSE a million dollars. Not the opportunity to make a million dollars, an actual million dollars. Clearly this does not happen. You are totally and entirely wrong here.
The market doesn't grow because new money flows in. This is mercantalism and your understanding of economics is hundreds of years old. The market grows because companies create REAL (not nominal) value that didn't exist before. I can explain this in more depth, clearly your financial friends aren't very good at their jobs (it's quite common).
The reason your oil trader friend agrees it's zero sum is because the futures market is zero sum. The stock market is not.
Okay, I accept that I could be entirely wrong. I had forgotten about the role of dividends in determining the value of a company, and that companies definitely do appreciate in real value on average. (I should also have clarified I was thinking only about a closed secondary market, as opposed to the primary market where funds flow into companies.)
What I'd like to understand is this: if the total real value of companies is expanding in the long term, then isn't the stock-trading/investment game about who manages to pick the fastest-growing stocks and capture the most price appreciation? The net gain in value would exist as long as people had invested in the first place, but its distribution is zero-sum in that the net gain in value is captured by someone or other. I guess this is what I was thinking of when I talked in earlier posts about "closing out" all trades - if all trades are closed out at one point in time, then all value in the market is captured by one player or another, and the result is zero-sum.
If the total gains in real company value are influenced by the trading game in the secondary market (e.g. total gains depend on the volume of trading in the secondary market, perhaps through new stock issues), then the question does seem a little more complicated.
Glad to have had this discussion. I guess I need to read up on economics more, although googling didn't turn up a lot of actual literature on stock markets and value-creation right away.
The more money is sucked from the market by intelligent arbitrageurs/gamblers, the less there is for small(er) investors. That's a bad thing in itself and also increases the focus on financial gameplay (analysis of market trends and fads) to the detriment of investment (analysis of the worth of companies). Frothy, ever-rising stock markets attract investment away from other markets, usually for poor reasons: the traded companies haven't done anything that would justify such rapid and significant changes in their stock values.
The point of the stock market is not to let the smartest people profit from the rest; it's to allow companies to raise capital efficiently and fairly. If we tweak the rules of the market, by limiting trade frequency for example, we may be able to push the play in the market towards a form that aligns better with this core function of the market.
Finally, I want to reiterate that for a closed population, the stock market is a zero-sum game. Money made is won from someone else, always.
edit: i'd appreciate you mentioning the points you disagree with when you give your downvotes - thanks