What is a Zero-Sum Game? | Definition and Examples


A zero-sum game is a scenario where one party’s gain equals another’s loss, resulting in a net change of zero. In simpler words, it’s a situation where if someone wins, someone else must lose. A zero-sum game is an important part of game theory.

Zero-Sum Game in a nutshell

  • A zero-sum game is a situation in which the gain of one party equals the loss of another, resulting in zero overall change.
  • Trading transactions such as futures and options contracts are examples of zero-sum scenarios in which there is a transfer of assets between the parties.
  • Poker and gambling are another examples of how one person’s loss contributes directly to another’s gain, creating a zero-sum dynamic.

Understanding Zero-Sum Game

A zero-sum is a situation in which two or more participants are involved. The transactions between them take place in such a way that what one person loses is a gain for another person. 

For example, if you visit a shop to purchase some groceries, you will have to pay the grocer the cost of the goods. The grocer might even charge some percentage of profit from you. In such a situation, you lose your money to the grocer. And, the grocer gains the cost of goods and extra profit. In this situation, there is no net change in wealth. The benefit is zero. It is the core concept of a zero-sum game.

Understanding Zero-Sum Games in Trading

In the world of trading, there exist several zero-sum games. Futures and options are common zero-sum games, because these are contracts that represent the agreements between two or more parties. If you exclude the transaction costs of futures and binary options, they form the perfect examples of zero-sum games. If any party in the contract loses, the wealth gets transferred and belongs to another party. A better way to understand this is to assume that every person who has a chance of gaining on a contract gets followed by a party who loses on a contract.

Zero-sum games are not part of trading only. Zero-sum games are also a part of poker and gambling. In these games, if a person loses any amount, another person gains it. All games where one person loses, and the other person wins are examples of zero-sum games.

Example of a Zero-Sum Game

Imagine a scenario where two players, let’s call them A and B, engage in a simple game known as “matching pennies.” Each player places a penny on the table simultaneously. The outcome is determined by whether the pennies match or not. If the pennies match (both heads or both tails), A wins and gets B’s penny. But if they don’t match, B wins and takes A’s penny.

This game shows the idea of a zero-sum game: when one person gains, the other loses. In the payoff table below, you can see their gains and losses balance out to zero.

Conclusion

A zero-sum game is highly prevalent in the world of finance and trading. Trading in itself is the best example of a zero-sum game. It is because a trader places his trade after considering his future expectations about a particular stock or an asset. Their risk preferences are different. Thus, if one person loses in trade, another person gains it. It is the whole essence of a zero-sum game.

About the author

Percival Knight
Percival Knight is an experienced Binary Options trader for more than ten years. Mainly, he trades 60-second trades at a very high hit rate. My favorite strategies is by using candlesticks and fake-breakouts

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