There is an element of snobbishness surrounding the financial and prediction markets. Those who engage in these forms of investment typically see themselves as being far from the madding gambling crowd. For generations, society at large saw sports bettors as ‘degenerates,’ usually clad in a dirty coat pathetically clutching a copy of the Racing Post or a similar publication.
The notion that sports betting is a ‘mug’s game’ persists, not least because of the appalling laddish marketing campaigns. Bookmakers specifically target punters who like to ‘have a dabble.’ These unfortunate bettors have little knowledge of probability and give up enormous edges to bookies. As a consequence, there is a prevailing idea that ‘the house always wins.’ For individuals who treat sports betting as an investment, the outlook is much brighter. They understand that ‘wagering’ on sports is no different from doing so in the financial or prediction markets. Indeed, there are several similarities which we cover in this article. By the end, we believe our readers will know that sports betting has immense potential as an investment IF you follow the best principles.
What on Earth are Prediction Markets?
Most readers have at least rudimentary knowledge of sports betting and financial markets. Although the clue is in the name, prediction markets carry an air of mystery to the uninitiated. A prediction market is a group of people who place bets on whether a specific outcome happens or not (sound familiar?) Events include presidential elections, the price of commodities, or a company’s quarterly sales results.
Political elections are often cited as a prime example of the value of prediction markets, and also how they operate. The definition of Arrow-Debreu security neatly sums up how this market works. This security is a contract that agrees to pay a unit of currency if a particular state occurs at a specific time in the future. The contract pays nothing in all other states.
PredictIt is one of the best-known prediction markets in the modern era. A quick visit there reveals various events, such as the outcome of the U.S. Presidential Election in 2020. Let’s say you believe that Donald Trump is going to retain his position as president. You can set a contract by accepting the current price of $0.42.
In this situation, it is a zero-sum game. If Trump wins, you get $0.42 for every ‘share’ purchased. If someone else becomes the president, you lose your entire investment. You also have the option to accept the contract, which states Trump will NOT win the election by investing at $0.59 per share.
Prediction markets are valued because they represent a wide variety of thoughts and opinions. They are known for being more accurate than polls when it comes to elections! They depend on the scale: The more people that participate, the more precise the market.
The true probability of an event occurring is more accurate on a prediction market than a betting website, for example, because of the ‘Wisdom of the Crowd’ phenomenon. The term relates to the collective opinion of a large group rather than a single individual. In general, the aggregated answers from a large crowd, to questions involving global knowledge, spatial reasoning, and quantity estimation, is more accurate than a single person in the group.
In such a ‘tight’ market, it is more likely for the equilibrium price to correctly represent the probability of the event occurring. In this scenario, the expected profit for the seller and buyer is zero. In other words, there is no discernible edge. For the record, the equilibrium price is the market price where the quantity of goods supplied equals demand. If the need begins to outstrip supply, the price goes up. If the supply exceeds demand, the price falls.
Given that prediction markets are accurate in the main, perhaps it is worth using them to succeed in betting! Bookmakers offer a wide range of odds on political events. For instance, Paddy Power offered odds of 2.20 on Trump winning the 2020 Election on the same day that the PredictIt site provided a contract of $0.42 on the same outcome.
The PredictIt contract suggests Trump’s correct odds of winning are 2.38. In this case, you get far better value on the prediction market than with the bookmaker.
The three markets: what is different?
Although there are several similarities between the sports betting, financial, and prediction markets, there are also a few differences.
In financial and sports betting, you have an opportunity to hedge your bets directly. The purpose of hedging is to reduce the risk faced. While prediction markets involve access to information to boost forecasting power, hedgers are only concerned with getting a reasonable hedging price to either lock down a profit or minimise loss.
Let’s say Gold X Mining knows that each $0.01 rise in the price of gold equates to $1,000 profit in the next three months, and a $0.01 fall equals a $1,000 loss across the same timeframe. It can hedge by going short in the futures market. To ‘short’ stock is to take a position in the belief that the price will fall.
In Gold X’s case, the company can enter the short market in a manner that completely offsets any losses. If the stock falls, the profit from ‘shorting’ covers any loss. If the stock rises, the company loses on the short market but ‘wins’ in the ‘long’ one.
In sports betting, hedging is also commonplace, especially on the exchanges where you have the option to ‘lay’ bets. For example, let’s say you place a €1,000 ‘back’ bet on Liverpool to win the Premier League at odds of 4.00 at the beginning of the season.
With three games left, Liverpool holds a one-point advantage over Man City and has to play their rivals away from home. At this stage, Liverpool’s odds of winning the league are 1.98. You could place a €1,500 ‘lay’ bet at odds of 2.00 as a hedge. If Liverpool wins the league, you make a profit of €1,500. If not, your hedge ensures you make a €500 profit.
In the world of finance, insider trading relates to trading a public company’s stock or other securities based on information NOT available to the public. It is highly illegal and may result in prison time if you are caught!
In contrast, insider trading is welcome in prediction and sports betting markets. In prediction markets, this type of information is crucial and allows for a more accurate price. In sports betting, ‘secret’ insider knowledge helps you make a bet at a better price than what is otherwise available.
In prediction markets, the emphasis is placed on the information provided by customers. The result is a price that has good forecasting value. You don’t always get the same benefit in sports betting. There are many occasions where the bookmaker fails to adjust its odds despite information gleaned from customers. Of course, this situation could prove beneficial if you end up with a value bet!
Things change when you enter the betting exchanges, however. The odds generating process is akin to what happens on prediction markets, which means you CAN receive forecasting value. As a bonus, ‘sharp’ players on the exchanges don’t suffer from the bans and restrictions imposed on the counterparts who use ‘traditional’ bookmakers.
Prediction, Sports, and Financial Markets: the similarities
This section will come as a shock to those who assume that financial or prediction markets are inherently ‘superior’ to their sports betting counterpart. We’re confident that by the end, you will see that there are far more commonalities than differences!
1 - Risk
Everyone wants to believe that they are a soothsayer capable of predicting the future. In reality, there is a risk involved in every single form of investing. In finance, even the disciples of value investing get it wrong now and then. In prediction markets, the same is true.
Avid sports bettors KNOW that for all their research, they can’t directly influence a game. If Manchester City miss 10 easy chances on any given day, there isn’t much you can do about it! All you can do with the three markets is to perform due diligence. If you are skilled, you will get more right than wrong and profit in the long-term.
2 - Information is power
No matter the investment niche, risking your money without having adequate information to hand is the definition of foolhardy. In the prediction market, you must understand the reasons WHY Trump is likely to win the next election, for example. Perhaps he is polling well in battleground states, or else your data tells you that Democrat voters are not sufficiently galvanised.
In finance, a sound investment is based on hours of detailed research, especially if the goal is to buy and hold. You must look into the company and check out its Free Cash Flow, Price-to-Earnings, and other key data.
If you don’t believe sports betting is similar, you are unlikely to have a successful track record! Professionals treat it as an investment and conduct a similar amount of research to those in the financial markets. These days, you can analyse an incredible amount of data about players, leagues, and teams. With the help of Big Data and AI, it is possible to gather enough information to determine the true probability of an event and profit from value betting.
3 - Leave emotion out of the equation
In all three markets, there is no room for emotion or sentiment. Successful players in the financial and prediction markets rely on evidence in the form of cold, hard data. It doesn’t matter whether they like or loathe Trump as a candidate, or advocate for the Ford car brand, the numbers don’t lie!
The majority of sports bettors, the unsuccessful ones at least, continue to fall prey to psychological biases. One of the most common is Gambler’s Fallacy, the idea that a bet is more likely to win if you have lost several in a row, and vice versa. The key is to understand that each wager is an independent event. Do you think Warren Buffett has this mindset when searching for value stocks?
However, it is a mistake to believe that everyone in the financial and prediction market is a calculating assassin. If every investor, or the vast majority at least, had a rational and sensible approach, the markets would look very different, and finding inefficiencies would be next to impossible.
Humans make mistakes. The successful investor knows this and takes advantage. They are not infallible either but make the ‘logical’ decision far more often than not. No matter what market you choose, such a mindset usually leads to profit.
4 - The price is right
In bookmaker versus punter models, sports betting has a slightly different dynamic to its financial or prediction counterparts. In the latter two cases, you ‘buy’ a stock after your offer is matched with the seller’s offer. This mechanism drives the price. In economics, a trade occurs when the demand meets the supply at a specific trading price.
In betting, you are up against a bookmaker who sets the odds. It is very similar insofar as all markets are zero-sum games. The main difference is that the bookmaker usually has a much higher ‘edge’ than you find on the markets on average. As a result, punters are at a significant disadvantage.
The advent of betting exchanges has changed everything. On the Betfair Exchange, for instance, you ‘buy’ at a price set by another player. In other words, the entire process is virtually the same as the stock market. The primary difference is that you are wagering on sports rather than shares.
In the financial and prediction markets, you can go ‘short’ or ‘long,’ just as you do with betting exchanges. In all three cases, you can cash out for a profit by leaving an advantageous position, or a loss if the market goes against you.
Conclusion - Which sector is the most profitable?
At present, most people would assume that the financial market is way ahead of the other two. The thing is, sports betting is reaching a never-before-seen level and is growing at an exponential rate. A 2016 study by Long Rock Capital suggested that sensible investments in sports betting could outperform the S&P 500 and hedge fund managers!
The average S&P 500 return since 1957, when it adopted 500 stocks into the index, is a very reasonable 7.96%. From 1994 to 2018, the S&P 500 outperformed every major hedge fund strategy by around 2.25% each year. Add in the high fees of the latter, and its return looks even less impressive.
In sports betting, professionals live off an ROI of between 3% and 4%. The overall return on capital is much higher because they invest a lot more than they would in a more passive investment environment.
At Mercurius, we use quality data gathered from Wyscout, along with their excellent algorithms to provide users with consistent value bets. Check out our returns to date; we believe you will be pleasantly surprised.