Game theory is about strategy and decision making. In every moment of our lives we try to make sense of things going around us. Who is doing what and why? The basic idea of game theory is understanding how people select a course of action. The fluctuations in the Stock Market is based largely on the psychology of the investors. In this context, understanding the relationship between game theory and the stock market can help us make wiser investment decisions.
Making Profit in Stock Market using Game Theory
Stock Market is a zero sum game. It means that the gain or loss of one participant in the game is equally balanced by those of another participant. In simpler terms, for every gain, there must be an equal loss. Game theory can be used to guide our strategic decisions in daily life and it can also be used to maximize our financial success. Using game theory, we can predict the behavior of others and align our strategy accordingly which is the basic of stock trading.
Psychology of the Stock Market
The stock market is fundamentally based on the law of demand and supply. Here, the sentiments of the investors come into the play. Whenever you are buying any stock, you buy it with the expectation that its prices will go up. You are literally betting (or gambling) on the stock you are buying. But the person on the other end of the transaction,i.e. the seller, is betting that the prices will go down. At the end of the day, there will be only one winner. Both the buyer and seller can not be correct in this matter. One is gonna win on his bet while the other is gonna lose.
Role of Information
Information is at the heart of game theory and stock market. You don’t know what the other investors are thinking about a particular stock. Maybe they have done sufficient market research regarding the direction of price. If you are not aware of such information, you are gonna lose in the market. You have to be careful in this matter because you can’t revert back your decision once the deal takes place.
Take your time. Share Market may be automated but it is still guided by the basic principles of Game Theory. Be a Value Investor like Warren Buffet.