Some notes about the DOW and Prediction Markets

August 4, 2006 at 7:58 pm Leave a comment

on us.newsfutures.com I have been correct on the DOW’s ending 4 times and the one time I missed I had invested in the correct outcome too. On intrade though I have pretty much lost all my money on the hourly DOW predictions. In fact I lost twice despite the market predicting a 94% and 74% chance the DOW would end the hour up. This was my original strategy to go with the most likely outcome and to invest only near the end of the hour, despite this I ended up losing two days straight. I’m now down to mere pennies (11 to be precise). Hence, the daily activity of the DOW is easier to predict than the hourly activity, secondly my original strategy was flawed do the nature of the shares system intrade uses. One share is worth 10 dollars. A bidder loses the cost of their bet, a seller loses the difference of their bet. Hence a 2 dollar bid loses 2 dollars, an 8 dollar sell would mean a 2 dollar loss.

The problem with my strategy of betting on the most likely outcome, is that even if the market is at 90% or even 20% the gains and losses will theoritically level out. Let’s take 10 markets in which we bid 90.0 when that’s the going rate. In theory we will win 9 of those auctions netting 1 dollar in profit each. However, we will lose the tenth auction losing 9 dollars pushing us back to our original amount minus 4 cents per bid in fees. Now if we had bought on a less likely outcome at 2 dollars theoritcally we could lose 8 auctions losing a total of 16 dollars, but gaining 16 dollars from our two wins (which is what I’m hoping for right now we my 1.0 bid on a high dow close).

Here is the problem though, what gives prediction markets their edge over polling is that an individual can express contradicting opinions, and later revise their outlooks by buying other shares, hence a 90% confidence at one point in the lifetime of an auction hardly means a guaranteed outcome (especially with the DOW most days). Hence a better strategy is buying contradicting positions when the market favors a price on a bid under 50.0 or a sell over 60.0. If one could in the lifetime of a market invest in both outcomes with low risk on yourself, then you’ve covered both bases. For instance let’s say you buy into the DOW ending 11 at +25 with a bid of 20.0 i.e. 2 USD. The dow then surpasses +25 so you then put in a sell for 90.0 risking 1 dollar against. Then the DOW procedes to trace a drunken line through expectations and end up somewhere else altogether. If you win the bid you win 8 USD if you win on the sell you get 9 USD hence your profits on either position outweighs the loses. Unfortunately, the market obeying such a regularilty that people feel safe making such bets is hard to find when you have 11 cents not to mention that some days the DOW is regular enough that my original idea of a safe bet is the better one. I’m a little pissed that my 1.0 bet on the dow higher wasn’t taken when the dow was at -50 ten minutes ago becuase it’s now at -2 and gaining…

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p.s. while I was writing this the DOW closed and someone sniped my 10 cent bid leaving me at 1 cent… so my DOW days are over. Thankfully I lost a meager 15 USD although it was a decent lesson.

Entry filed under: my life through software.

Ted Talks McDonald’s

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