The Game Theory: Relevant In Stock Market?

While flipping through my old MBA notebooks, I recalled an intriguing concept— The Game Theory.?

It’s fascinating how, whenever large groups of people are involved, patterns of common psychology emerge, creating opportunities for those who understand them.?

And guess what? This applies to the stock market too, yet very few truly grasp how!

Stock markets aren’t just about numbers—they’re a playground of strategy, psychology, and anticipation.?

Every investor, from big institutions to retail traders, unknowingly engages in a game where their decisions are shaped by what others do.

Whether you realize it or not, you’re constantly going through scenarios like the Nash Equilibrium, the Zero-Sum Game, or the Prisoner’s Dilemma—classic examples of Game Theory in action!

Let’s break it down and see how understanding this can give you an Edge in the markets.

What is Game theory?

Game theory is the mathematical study of strategic decision-making where the outcome depends on the choices of multiple participants (players).?

John von Neumann invented this while pursuing his love- Maths and Poker!

According to him, wherever there are more than 2 players, strategy and payoffs, a consistent psychology or behaviour will follow.

This theory will help analyze and take advantage of? situations where individuals or groups make decisions that impact each other, often leading to competition or cooperation.

Got the bookish definitions?

Now lets make you understand few of my favorite principles with examples in the Markets-

Nash Equilibrium?

When Reliance Jio launched in 2016 with low data prices, Airtel had to follow suit to retain customers.

The Nash Equilibrium came when:

• If both companies cut prices, they both lose profits but maintain market share.
• If one cuts and the other doesn’t, the one that cuts gains customers, but the one that doesn’t lose.

The best strategy for both was to keep prices competitive but stable, as neither can benefit by changing alone.

In this case, both companies settled on a balance where further price cuts or rises would harm both of them.

Prisoner's Dilemma (Cooperative Trading Strategy)

The Prisoner’s Dilemma shows how selfish actions, motivated by “benefiting myself first” thought process can lead to worse outcomes for everyone, even when cooperation is the best choice.

Lets take an example of the Yes Bank Crisis (2020)

During the Yes Bank crisis, depositors feared losing their money and rushed to withdraw it.?

Each person thought withdrawing was the safest move for them, but when everyone acted out of fear, and to safeguard their interest first, it triggered a bank run, worsening the situation for all.

Had they all co-operated and held on, impact would have been much lower.

Tragedy of Commons

The Tragedy of the Commons happens when players or individuals act in their own self-interest, overusing a shared resource and causing harm to everyone.

The 2008 Financial Crisis is a classic example.?

Banks and investors took excessive risks in the housing market, thinking they could profit without consequences.?

But when the bubble burst, it devastated the global economy. If everyone had acted responsibly, the damage could have been avoided.

The stock market is a place where people tend to follow the “Trend”.?

And this trend many times follows these psychological principles of Game Theory, making them predictable.

What are your views on this?

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