Financial betting is similar Fighting cock betting betting on sports – except that you bet on a market outcome, instead of a match.
As with sports bets, with financial bets there is a:
• stake or wager – how much you are willing to bet
• payout – the amount you will receive if your bet wins
• return or odds – the ratio between the payout and the stake
• outcome – the “prediction” you are making
So, for example, you could make at bet as follows:
• wager – $10
• payout – $20
• return – 100%
• outcome – the FTSE (London Stock Exchange Index) to rise between 13:00 and 14:00 today
Pretty easy, huh?
So why bet on the financial markets?
• Because it is easy
• Because it less risky than trading (you can bet with as little as $1)
• Because it exciting
• Because you can make money
That last point is important. You *can* make money. But you *can* also lose money, of course.
In order to be profitable over the long-term, you need to find low-cost, mis-priced bets. What do we mean by that?
Financial betting services are businesses. And like any business, they have expenses to cover and investors to please, and so they try to make money. And they make money by effectively charging “fees” on their bets.
Except that they actually do not charge fees (such as $5 a bet) or commissions (such as 2% of the winnings), instead they use a spread or overround (two different ways of looking at the same concept, so we’ll just refer to it as a spread). This spread means that if the fair value of a bet is $x, they sell it at a price of $x + y, where y is their spread. On average and over time, their betting profits should be equal to the spread.
This is why it is critical to only place bets on those bets that have low spreads – eg “good prices”. If the spread is low enough, then you can be profitable in the long run if you make good predictions. If the spread is quite high, then you basically have no chance, no matter how good your predictions.
The challenge is that betting services don’t make it easy to figure out what their spreads are. So you need to understand how they price bets, and then you can understand the spread, and thus how good the price is. There is usually a very easy way to figure out the spread, and we’ll get to that in a minute. But first it is probably helpful if you understand how betting services determine the “fair value” of the bet, which they then add the spread on top of to give you the final price.
Financial bets are a form of option (in fact, they are also called binary options, because the outcome is “binary – you either win or lose, nothing in between). And there is widely accepted way of determining the fair value of an option – its called the Black-Scholes model. This model is widely used in the financial markets and other industries to determine the fair value of an option.
Although the model is pretty complicated, it can be boiled down to: the price increases as time increases and as asset volatility increases (volatility is a measure of how much the asset prices move per unit time). So if one bet is for a one hour period, and if one is for a one day period, the one day bet price will be higher. And if one bet is on a calm market, and one is on a stormy market, the stormy market bet price will be higher.
There is a huge amount of information available about “predicting the markets” – just Google that term or “winning trading strategies” or “make money markets”, etc. And much if not most of this information is total garbage.
If we knew of a “foolproof” way to make huge profits in the markets we’d be (insert retire young and rich fantasy of your choice here). But that is not the reality. The reality is that the markets are often very unpredictable, and at most times approximate a “coin flip” where you have a 50% chance of being right. So if you can be right 55% of the time, you are doing a good job. Correct 60% of the time and you are doing a really good job. Correct 70% of the time and you are world-class.
Your objective should be to get you into the 55-60% correct range. If you can do that, and only make low cost bets, you can earn a 3-8% return on investment (ROI).
So how to achieve that 55-60% win rate? Well remember that financial bets are done in pairs, such as a “rise/fall” pair or a “hit/miss” pair, etc. And the total probability of each of these occurring needs to add up to 100%, so if the probability of one side occurring is 60%, then the probability of the other side occurring must be 40%.
We suggest that you look for bets that are *favorably* mis-priced. This means that the probability implied in the bet price is *lower* from the probability implied by the your predicting method. If you choose the pair that has the favorable mis-pricing, you will win over time (and remember if one side of the pair is favorable, the other must be unfavorable by an equal amount and you should avoid that side of the bet).
Here is a simple example. Say you had a fair coin which had a 50% chance of heads and a 50% chance of tails. If someone offered you a bet which was priced where the heads was assumed at a 45% chance and the tails at 55%, you’d be foolish not to bet on heads. Why? Because they are pricing heads as if it will win 45% of the time, when you know it will win at 50%!
And so how do you find mis-priced bets? There are a few ways:
– the betting service is taking the easy way out and pricing each side of a bet at a 50% probability when in fact they are not at 50%.
– the betting service is over-complicating things and pricing each side of the bet different from a 50% probability when in fact they are at 50%
– the betting service makes an error in pricing and the total probabilities for the pair do not add up to 100%
Now there are literally millions of potential financial bets available at any given time and so finding these mis-priced bets is not easy, because in fact most bets are correctly priced.
Some of you with experience in the financial markets may be asking “but what about actually *predicting* the markets – using economic news or chart patterns or tea leaves to predict exactly what the market is going to do? How come you don’t help me with that?”
Good question. And the answer is because we largely believe in the random walk hypothesis. This hypothesis says that financial asset prices are inherently unpredictable the vast majority of the time, and particularly for the relatively short time periods that most financial bets cover. Note that the Black-Scholes model, and thus option pricing and financial bet pricing, also assume a random walk. So we don’t bother to try to predict the market, we focus on finding cheap, favorably mis-priced bets, because these should, on average, get you to a 3-8% ROI per bet.
Now if you are a believer in fundamental analysis (using economic news and data to predict future prices) or technical analysis (using price chart patterns to predict future prices) or tea leaves (using gut feel or randomness generators to predict future prices) and have had some consistent success with these then we say kudos and keep using those to make predictions.