Previously: Wiser Than The Stock Market —- NOT
Ben Shannon (alias “-Jesse Livermore”-, who blogs at “-Wiser Than The Crowd”-) claims on his blog to have an uncanny ability at forecasting the future and profiting from it, whether it is speculating on InTrade’-s prediction markets or on the US stock market. Here is his stock market call from July 10, 2009:
SELL SELL SELL
The stock market is up about 12% since Ben Shannon’-s “-sell sell sell”- call on July 10th.
Spot the 10th on the chart…- Ben Shannon sold the exact bottom immediately before the rally.
Thanks to Deep Throat for the tip.
[This article is cross-posted from Major Wager.]
A recent article in the prestigious academic journal Science (May 16, 2008, Vol 320, p. 877-8) once again makes the case for regulated prediction markets, more commonly known as “-betting exchanges”- to online gamblers. The authors make the case that such markets are useful in forecasting future events with less error than traditional measures such as polling. This argument is hard to ignore, with the authors including 21 top economists from such esteemed institutions as Yale, Stanford, Berkeley, and the University of Pennsylvania. Notable among the authors is Justin Wolfers from the Wharton School of business at UPenn, an economist who has gained notoriety in gambling circles due to his work on such topics as NBA referee bias (highlighted in a May 2008 article from MajorWager: http://www.majorwager.com/index.cfm?page=27&-show_column=660).
The concept behind using prediction markets as a decision-making tool is simple. “-Shares”- are made available on an open market, and the participants use their capital (and the promise of profits) to make predictions on future events, which is incorporated into the share price. In general, information tends to be widely dispersed, and a market allows wide-ranging opinions to be gathered and consolidated into a market-wide prediction. In other words, an infinite amount of opinions can be aggregated, and an open market with potential for profit provides an incentive for individuals to make their opinions publicly known.
Prediction markets always get more than their fair share of press near the end of the 4-year U.S. Presidential election cycle. The Iowa Electronics Market, housed at the University of Iowa, is perhaps the most well-known. The authors of the Science paper show that, in the week immediately preceding the Presidential elections from 1988 through 2000, the Iowa Electronic Markets erred by an average of only 1.5 percentage points from the actual vote results, while the traditional Gallup poll was off by 2.1%. Numerous other studies have shown the superiority of markets compared to other forecasting tools.
Of course, there have been some dust-ups regarding prediction markets in the past, most notably the “-terrorist strike market”-, unveiled a little too close to 9/11 to be palatable to the general public. The official name was the “-Policy Analysis Market“-, and it was established by the Pentagon to act as a prediction market for Middle East political events. It was quickly scuttled after heated comments from U.S. Senators, calling it “-grotesque”- and “-stupid”-, due to the perception of using catastrophic events such as assassinations as profit-making tools. Regardless of its political correctness (and the misinformed opinions of a few politicians), such a prediction market still holds value as a glimpse into the collective mindset of everyone with an understanding of political currents in the region. Utilizing such a prediction market as a component of foreign policy decisions may have ultimately spared the U.S. much grief in Iraq.
In recent years, prediction markets have grown beyond academic and government roles. Dublin-based InTrade is rapidly growing and provides many more options than the Iowa Electronic Markets. Others such as MatchBook have focused more on sporting contests, but provide coverage of other events as demand calls. Of course, those outside the U.S. have access to the largest betting exchange of them all, the massive European markets of BetFair. The success of these exchanges speaks to the public interest and feasibility of prediction markets.
One factor holding back the growth of online prediction markets is their close association with the quasi-legal world of sports betting and internet casinos. InTrade has been fairly proactive in this regard, spinning off from Tradesports to clean up its corporate slate, but it is still knee-deep in the legal sludge surrounding offshore “-gambling”-. All have to deal with the legal and financial hurdles of operating offshore.
The authors of the Science paper propose that clarification of internet gambling laws is needed to exploit the benefits of prediction markets within the United States. Clearly, the Unlawful Internet Gambling Enforcement Act (UIGEA) of 2006 is one such mechanism restricting the widespread use of prediction markets. Another is the Commodity Futures Trading Commission (CFTC), the regulatory agency which oversees futures markets in the U.S. The CFTC has provided a “-no-action letter”- to the Iowa Electronic Markets, an assurance that they will not seek any enforcement action against the exchange. However, this protection is not absolute and may not trump state and federal law if challenged. The Science authors propose a number of legal reforms which will allow prediction markets to begin to gain acceptance within the U.S. financial regulatory structure.
By no means does the Science article condone large-scale public markets, at least not initially. They take a (typically academic) conservative approach, recommending new legal framework to allow for the establishment of small markets with limited scope so as to evaluate the promise and use of prediction markets. But baby steps are going to be a necessity in the growth and acceptance of regulated public markets.
Clearly, there are negative aspects to financial markets, and regulation certainly has its place. Bear Sterns, Enron, the S&-L scandal of the 80s, and the current housing bubble all caused tremendous loss of wealth resulting from missteps in the financial markets. The current oil crisis is due at least in part to speculation, leading to the introduction of no less than 9 separate bills in the U.S. Congress seeking tougher regulation over the trading of commodities. However, the existence of problems in the financial markets does not necessitate their dissolution. Likewise, prediction markets are sure to encounter bumps in the road, but their utility should far outweigh the risks.
Should prediction markets be legalized in the U.S.? Almost certainly. They would have benefit across numerous industries, from business decisions to political policies to financial forecasting. Unfortunately, this would require building an unlikely bridge over the Puritanical moral moat placed around gambling in the U.S. But there is no inherent difference in betting on who will win in an election than what the price of oil will be in 6 months, or what the S&-P 500 will close at on a particular date. Distancing prediction markets from “-illegal”- gambling, and instead likening them to regulated financial markets, will be a necessary first step towards broader acceptance.
The academic groundwork on prediction markets has already been laid, and offshore exchanges have begun to turn these concepts into functioning businesses. As these markets grow and begin incorporating more diverse opinions, we can expect their success rate at predicting the future to only grow. To restrict such a promising tool simply due to its perception that it is a gambling outlet is silly indeed.
[This article is cross-posted from Major Wager.]
A futures contract is an agreement between a buyer and a seller. It obligates the buyer to take possession of a specified amount of a given commodity or financial instrument and to do so by a given date. Likewise, it obligates the seller to deliver (sell) a specified amount of a given commodity or financial instrument by a given date. The specified date is the expiration date of the futures contract. Futures contracts lock in current prices, that is, the prevailing prices at the time the contracts were bought or sold. This protects both the buyer and seller against the risk of price change between the moment of the contract transaction and the time of delivery (the expiration date). Futures contracts can be bought or sold at any time by anyone and they can change hands any number of times before expiration.
Related to the expiration date is the first notice date. This is the date after which the contract holder may be required to take possession (if long) or to deliver (if short) the specified quantity of the underlying commodity. After first notice date, those who are long futures contracts can demand delivery and those who are short may be required to deliver. Futures speculators who want to maintain a position past first notice date “-roll over”- their contracts to others that have later expiration dates.
Futures contracts may be used in several ways. For example, producers of commodities use them to hedge risks. A grain producer may have 10,000 bushels of corn that will be ready on a given date, and he or she wants to lock in specific sales price on that date. Locking in the price with a futures contract avoids the risk of vagaries in the corn market. Consequently, the use of futures allows the producer to budget and plan, knowing what price to expect on delivery. The way the producer ensures the price is by selling futures contracts. The buyer of futures contract is then obligated to take delivery of the corn on a given date, at the specified price.
For the speculator [or] day trader, futures contracts are used purely as trading instruments. They enable profits to be made from correctly anticipated price changes. For example, a trader expecting stocks to rise can profit from the anticipated move by going long an S&-P 500 or E-Mini contract. To avoid acquiring the commodity and then having to turn around and sell it, speculators generally do not hold futures contracts past expiration or first notice date.
Today, futures trading on modern exchanges is highly standardized. Future contracts have fixed expiration dates and contract sizes, and each contract is identified by a unique symbol. Specifying a futures contract, such as when requesting a quote or placing an order, requires knowledge of the month in which the contract terminates or expires, and the root symbol used to identify the contract series.
Cross-posted from “-What are futures?“-. Please, visit Tony Reed’-s home page, Futures Trading &- Futures Market, for more information.