Why Sports Betting and Stock Picking Are Similar

So how did everyone do in their March Madness pool? In the book Wise Investing Made Simple by Larry Swedroe, there is a great explanation of why stock-picking is very difficult which incorporates sports betting. I’ll try to briefly paraphrase the idea here.

Sports Betting Basics
Let’s stick with college basketball. Earlier this season, Duke played Cornell. If you were simply betting on who was to win beforehand, most people familiar with basketball would pick Duke. Duke has won national championships, has a top-ranked recruiting class, has a famous coach, has better record against stronger opponents.

But, nobody in Vegas or any sports book will take that bet. Instead, you have an adjustment called the point spread. In this case, the spread was 30 points. Now you have to either bet that Duke will beat Cornell by more or less than 30 points. This is much harder.

How was this 30 point spread determined? By the collective opinion of the other gamblers! It is a common misconception that you are betting against the casino. Nope, the point spread constantly moves so that half of all bettors are on either side of the spread. By the time the game is over, the casino doesn’t care who wins. The casinos simply take the bets, pay off the winners, and walk away with their commission. (You have to bet $11 to win $10.) Great deal, huh?

Because of this point spread and commissions, it is very difficult to make consistent money betting on sports. How many professional sports bettors do you know of? A historical study of NBA games showed that the average difference between point spreads and the actual differences in score was less than 1/4 of one point! The collective opinion of gamblers turns out to be very good.

In other words, with the handicap of the point spread, you could bet on Cornell every year and still come out the same as betting on Duke each year. (This year, Duke only won by 13.) When this is true, it is called an efficient market.

Picking Stocks
When people say “buy a company with a strong brand, a wide moat, and good growth prospects”, it is like saying one should just bet on Duke to win. It’s simply not that easy. There is a handicap, but instead of a point spread it is the price of the stock.

A good company will be priced at a premium. For example, people may love eBay, Apple, or Google and think it’s the best business company ever. But at the price you have to pay (the market price), you’re not betting that eBay will be successful, you’re betting if eBay will be more successful than the collective market participants think it will be based on all the information currently available. Again, the data shows that beating this collective prediction is very unlikely.

The argument over whether you can get better risk-adjusted returns from picking individual stocks will probably go on forever. Is it skill? Is it luck? Either way, it is important to know that very few people pull it off over the long term, and I think this analogy illustrates one major reason why. Next time you feel like stock picking, try beating the spread on 10 different sports events first. :)

Comments

  1. Interesting. I used the yahoo generator to select the most popular picks and still lost (44 out of 63). Are the popular picks like an index fund? say s&p 500?

  2. Ha. I’m not a fan of sports, but this is a good and simple analogy.

    I’d be curious what form of the hypothesis sports fall under. Probably weak or semi-strong, as there’s got to be private information (e.g. injuries) which could affect the spread (ie, price).

    And it sounds like what you’re saying is that I should start betting on high school sports. Since they’re followed less widely, I can exploit the limited knowledge the few bettors have and get a better spread. Like small-caps.

    James

  3. Interesting analogy. I agree that for most people investing in stocks looks like gambling ( and that’s why the majority loses). If you step aside though, and think about it, you will realize that you are buying into a business. You are creating value for everyone else though your investment.
    In investing though, you can have average performance, and still outperform 80% of active participants over time.. In gambling though, you have to to perform exceptionally well, and you can still lose money.. In addition, if the casinos ( or the betting companies) identify you as a winner, they would make sure that they discourage you from playing and winning. I am not aware of any brokers that would stop you from investing just because you are successful..

  4. Baba Ghanoush says:

    Your point that company quality is already part of the stock price applies to market timing as well. Before you consider a timing move like buying health care cause the boomers are getting older or buying energy sector because we’re entering/exiting a crisis, ask yourself what you know that the rest of the market doesn’t know. Because if it is common knowledge, it’s already priced into the market. Reading _A Random Walk on Wall Street_ really brought this home for me.

  5. This is a great analogy and I actually used a financial technique, arbitrage, to consistently win at sports betting until the US government cracked down on sports gambling in January of ’07. It all comes down to a search for value. Another point to be made it the similarity between bookies vig and the fees that money managers charge. Both stack the odds against the average person by eating away at returns slowly over time.

  6. From a speech by Charlie Munger (Warren Buffet partner), very applicable but a bit long:

    The model I like to sort of simplify the notion of what goes o­n in a market for common stocks is the pari-mutuel system at the racetrack. If you stop to think about it, a pari-mutuel system is a market. Everybody goes there and bets and the odds change based o­n what’s bet. That’s what happens in the stock market.

    Any damn fool can see that a horse carrying a light weight with a wonderful win rate and a good post position etc., etc. is way more likely to win than a horse with a terrible record and extra weight and so o­n and so on.But if you look at the odds, the bad horse pays 100 to 1, whereas the good horse pays 3 to 2.Then it’s not clear which is statistically the best bet using the mathematics of Fermat and Pascal. The prices have changed in such a way that it’s very hard to beat the system.

    I used to play poker when I was young with a guy who made a substantial living doing nothing but bet harness races…. Now, harness racing is a relatively inefficient market. You don’t have the depth of intelligence betting o­n harness races that you do on regular races. What my poker pal would do was to think about harness races as his main profession. And he would bet o­nly occasionally when he saw some mispriced bet available. And by doing that, after paying the full handle to the house ? which I presume was around 17% ? he made a substantial living.

    You have to say that’s rare. However, the market was not perfectly efficient. And if it weren’t for that big 17% handle, lots of people would regularly be beating lots of other people at the horse races. It’s efficient, yes. But it’s not perfectly efficient. And with enough shrewdness and fanaticism, some people will get better results than others.

    The stock market is the same way except that the house handle is so much lower. If you take transaction costs ? the spread between the bid and the ask plus the commissions and if you don’t trade too actively, you’re talking about fairly low transaction costs. So that with enough fanaticism and enough discipline, some of the shrewd people are going to get way better results than average in the nature of things.

    It is not a bit easy. And, of course, 50% will end up in the bottom half and 70% will end up in the bottom 70%.But some people will have an advantage. And in a fairly low transaction cost operation, they will get better than average results in stock picking.

    How do you get to be o­ne of those who is a winner ? in a relative sense ? instead of a loser?

    Here again, look at the pari-mutuel system. I had dinner last night by absolute accident with the president of Santa Anita. He says that there are two or three betters who have a credit arrangement with them, now that they have off-track betting, who are actually beating the house. They’re sending money out net after the full handle a lot of it to Las Vegas, by the way to people who are actually winning slightly, net, after paying the full handle. They’re that shrewd about something with as much unpredictability as horse racing.

    And the o­ne thing that all those winning betters in the whole history of people who’ve beaten the pari-mutuel system have is quite simple. They bet very seldom.

    It’s not given to human beings to have such talent that they can just know everything about everything all the time. But it is given to human beings who work hard at it ? who look and sift the world for a mispriced be that they can occasionally find o­ne.

    And the wise o­nes bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, they don’t. It’s just that simple.

    That is a very simple concept. And to me it’s obviously right based on experience not only from the pari-mutuel system, but everywhere else.

    And yet, in investment management, practically nobody operates that way. We operate that way ? I’m talking about Buffett and Munger. And we’re not alone in the world. But a huge majority of people have some other crazy construct in their heads And instead of waiting for a near cinch and loading up, they apparently ascribe to the theory that if they work a little harder or hire more business school students, they’ll come to know everything about everything all the time.

    How many insights do you need? Well, I’d argue: that you don’t need many in a lifetime. If you look at Berkshire Hathaway and all of its accumulated billions, the top ten insights account for most of it. And that’s with a very brilliant man Warren’s a lot more able than I am and very disciplined devoting his lifetime to it. I don’t mean to say that he’s o­nly had ten insights. I’m just saying, that most of the money came from ten insights.

  7. Indeed, and this is exactly what makes stock picking so difficult. However, your analogy breaks down because in a casino, you have to pay to play. In the stock market, you get to see the hand you’re dealt before deciding to bet or not. It makes things a lot easier.

  8. It is true that there is the potential to gain and/or loose money gambling on sports or investing in stocks. However, there is one important difference. In sports betting (or any type of gambling) the expected return is negative. If you continue long enough you will eventually loose all of your money. Investing has a positive expected return, history has shown it to be approximately 7% per year.

    So, you can make some comparisons to these two, but there is a huge underlying distinction between the two.

  9. Matt Good says:

    Yep – turns out large groups of individuals are very good at weighing uncertainty. The individuals may have wildly different opinions, but the collective opinion of the whole is often spot-on. At least, that’s how I understand it. To me and my just-enough-to-be-dangerous knowledge about these sorts of things, efficient markets have always seemed closely tied to prediction markets, genetic algorithms, and emergent behavior (wikipedia them for more info). All those concepts take a bottom-up approach to solving problems – i.e. “Lets throw lots of these tiny actions at this situation, give them a little information, and see what they come up with.” You really do have to know something that others don’t to beat that kind of situation.

    I was actually talking about this with a friend yesterday. I think the main roadblock to understanding this is a person’s difficulty with understanding how they fit in to a system. A person may think they know something that “the market” doesn’t, and buy/sell a stock because of it. But of course, it is actions like this that actually create the market, and keep it efficient. They feel like they are acting independently of the system, but in fact ARE the system.

    I’m really no expert in this area, but these are the things I think about when I’m bored. Okay, I’m a nerd, so what?

  10. That is very interesting. I’m not that into sports, but I would say that picking stocks is more like picking teams with a good season, rather than a particular game. Like the Yankees — they are like Coca Cola, they always do pretty well. They don’t always win, but they are a quality team.

    As far as the consensus guessing within a 1/2 point — that’s pretty cool. I always think of masses of people as being slow-witted (like in a movie theatre, when there’s a funny scene, it will take the audience a few minutes to start and complete laughing). But maybe there’s a collective deepness of thought there.

  11. I totally agree – when it comes to day trading. However as far as single stock picking for long term investment, that is a higher percentage more strategic pick.

  12. toasty aroma says:

    True, sports betting and stock picking are similar, in all fairness, because you can do some analysis on sports betting I suppose. However, you can beat the stock market by picking stocks if you are good. You have to pay attention to fundamental analysis as well as technical analysis. You also can’t treat individual stocks like the market as a whole – you have to be willing to dump your shares when the crap hits the fan – like Bear Stearns – and buy at support levels or on strong earnings, etc. Otherwise you just become cannon fodder for the pros. The reason most people lose (as I have) when they begin stock trading is because they get frustrated at their initial losses and then give up.

  13. Thank you Jonathan;

    I understand zero-sum games, but I’m happy to see that you’re trying to make this connection for everybody. This is really important to know: trading stocks is like sports betting is like playing poker is like real estate investment you gotta win money from somebody else, so you have to somehow be smarter than the crowd. (mind you real estate investment is not as obviously zero-sum, but it works out).

  14. “A good company will be priced at a premium.”
    “Is it skill? Is it luck? Either way, it is important to know that very few people pull it off over the long term”

    Two words: Warren Buffett.

    A few more words: To be a successful investor, you don’t need any superpowers. Or insider knowledge. Or phenomenal luck. What you need is a rational mind that does not get swayed by emotions, and patience. Lots and lots of patience.

    A “good company” is not always priced at a premium. That’s exactly how Buffett became so successful as an investor: he identifies a good, reliable, profitable company and waits for its price to go down. He did that with GEICO, American Express, Wells Fargo, etc. While not anybody can be a Buffett, everybody can employ the same principles: buy really low, don’t sell unless you absolutely have to, make sure you understand what that company does (which is why so many people lost their money in the dot-com bubble), etc.

    To summarize, equating investing with gambling is very 1920s of you. There is a lot more to it, and it doesn’t take a genius to understand that. ;)

  15. I was wondering how much Mr. Buffett and Munger would show up in the comments. :)

    The point is, even if it is skill, why aren’t there more Buffetts? Name 20, or even 5, other people with a similar track record across a long time frame and number of different companies. Hundreds of thousand of MBAs, mutual fund managers, mutual funds, holding companies. In an industry that would shower millions if not billions on someone with such skill, most people might come up with 2-3 names. I’m not impressed.

    So regardless if Mr. Buffett makes it seem easy in his shareholder letters, to me this information is equally as convincing that it is hard. Very hard. And that is more important than luck or skill argument.

  16. Note that this doesn’t mean I wouldn’t try to actively manage a portion of my portfolio. Many people like the challenge, including myself at times. But I think people should be realistic in their expectations.

  17. I can see my husband is beating the spread in the NBA consistently. I document it here: http://mylifeandart.typepad.com/wagering

    From what I can see, proper handicapping requires just as much time as the research of the winning stocks.

    The odds are inefficient at the beginning of the season and during the play-offs. So, if you can make use of the statistical data that is available to everyone, you can exploit these inefficiencies.

    At the middle of the season it becomes really hard to beat the odds.

    The play-offs, however, present a new situation again and odds for a while become inefficient again for at least 3 weeks or so.

    You can follow my husband’s game (use link above) as soon as the NBA play-offs start. Feel free to ask any questions.

  18. Jonathan:
    The reason there aren’t many Buffetts is because what he does is often counterintuitive, even though it makes perfect sense in retrospect. An example would be his purchase of American Express when everybody thought it would go belly up, or his investment in Wells Fargo during a bear market a couple of decades ago. In my opinion, the main thing that makes it difficult for all of us to be like him is his consistency and patience. He has never sold any of his assets (“our favorite holding period is forever”), and he loves bear markets because that’s when he can buy his favorite companies at a huge discount.

    Another big thing is being able to resist the peer-pressure from fellow investors. He was one of the few who didn’t spend a penny on dot-com companies or the “go-go” funds of the 1960s.

  19. “I’m not that into sports, but I would say that picking stocks is more like picking teams with a good season, rather than a particular game. Like the Yankees — they are like Coca Cola, they always do pretty well. They don’t always win, but they are a quality team.”

    NY Yankees are currently 7:1 to win World Series. If you bet $1 and they win, you get $7. If they don’t win it all, you lose the $1. Would you still bet? :)

    Pittsburgh Pirates are 201:1 to win World Series. Nice.

  20. Frozen Calzone says:

    Like anything else in life; learning the stock market takes time, drive, and the willingness to “not give up.”

    To many people today look at something that is different, hard, or out of the comfort zone and decide not to do it because they make some excuse. I don’t have time, making 15-20% a year is not possible, it is like gambling, it is to complicated, I can’t buy stocks at a discount, etc. etc. etc.

    This is what the “market” wants you to think. This is what all the big investment firms want you to think. This is what your financial planner wants you to think. You don’t have the time to invest money yourself. Let the professionals do it (for my 2-5% fee of your portfolio) and you focus on what you do. Well, you can focus on what you do and still learn the market and make money.

    Smart traders take emotion out of the picture and use tools to increase the probabilities of a winning trade. If I could tell you that you will have a 60-70% chance that investing in the Yankees (see Jonathan’s post) will give you a 7 to 1 winning ratio would you do it? I would and do every day.

    Don’t get down on stocks, learn more and take your net worth to the next level.
    Start out by learning about ETF’s and stop buying mutual funds and make more money.
    OUT

  21. Good write-up. I was thinking about this same topic myself. The poker vs. investing comparison is also a good one, I’ve made it before: http://smallchou.com/blog/2007.....and-poker/ .

    As someone who has made some money betting sports, I can tell you that it’s possible to have a long-term trend of positive expected value in sportsbetting. Mostly you would make your money most advantageously when the lines are initially set by oddsmakers. You’re right that the line shifts, but it shifts to try to even out any future bets 50-50. So if an oddsmaker has set a “poor” line, they’ll try to correct it to even out future bets, but any bets that were made before the line shift can have some statistical advantage.

    In general, trying to beat the spread consistently after it has had substantial time to move is not positive expected value. That’s why betting on second-half stats for game can often be very useful – there’s very little time for the lines to move to adjust for “poor” lines.

    Also, one key difference between stocks and sports betting is the discrete nature of events. In stocks, unless a company gets sold or goes bankrupt, there is no final determining event (at least not really). In sports, there clearly is, so even if you think the true value of a sports team over time is “best team,” there’s a higher likelihood that the team will never reach a price that matches that value (i.e. the game ends).

  22. Jonathan: I wouldn’t bet this hypothetical $1 on the NY Yankees now because we don’t know if they will be even in the play-offs.

    I’d rather wait till the end of the season to make sure that they are in the play-offs to be eligible for the World Series.

    We can have a much better idea on the strengths and weaknesses of the teams as the season progresses. For example, the last 2-3 years a 20:1 and a 10:1 team (odds at the beginning of the play-offs) came in.

    Because the Series are so short a team that is listed as 10:1 or even 20:1 at the beginning of the play-offs is almost as likely to come in as a 2:1.

  23. “He has never sold any of his assets (”our favorite holding period is forever”),”

    That’s simply not true. Warren Buffet sold China Petrol, U.S. Air, etc.
    When valuations are too high, he sells. With U.S. Air, he decided it was a mistake to buy. Also, I don’t think he’s going to hold on to his Brazilian Reais forever.

    Although he didn’t buy any dot-com stock, he did invest in Amazon.com corporate bonds.

    “Name 20, or even 5, other people with a similar track record across a long time frame and number of different companies.”

    Peter Lynch, George Soros, Carl Icahn, Jim Rogers, Arnold Van Den Berg, Mario Gabelli, etc.

  24. So if the ineffiiciency is in betting at the initial line in sportsbooks, would that translate to IPOs in stock prices? Too bad most regular investors don’t get to participate in IPOs.

  25. I’ve won my NCAA tourney two of the last three years. Three years ago, I entered a pool of a group of bloggers, there was no entry fee yet I managed to net just short of $100 (after PayPal fees). Yes, I did pick all Final Four winners, and Kansas as the winner (Rock Chalk!).

    I had a fairly systematic method. I used publicly available rankings which ranked teams based on some formula of wins/losses, points scored/allowed, strength of schedule, and who knows what else. From that, I did make a few gut calls, especially on teams that were ranked very very close together, or teams that were on an incredible hot streak, or teams that got to play a little closer to home than the high seed (Kansas State, although that was an upset over USC).

    The key though was not using my gut too much, like last year. I picked more ‘gut’ picks, and ended up picking the wrong one more often that not.

    I do see a lot of parallels in keeping things simple in investing, just like sports picking.

  26. I’ve been making money betting on sports (mostly just baseball) for 5 years now. Not a ton of money. But, enough to suplement my income every year. There are bad lines out there, just like there are stock that are misvalued. It just requires a lot of patience.

  27. Can anyone recommend any betting advisor services?

  28. LAdude: I don’t want to discourage you from betting on sports, but here is what I have learned from my husbands daily wagering on NBA and MLB.

    From my experience, you have to play consistently, if you can’t play every day and most people can’t because they have other responsibilities, you have a slim chance to make money in a long run. And no advisor services will help because if you can’t place every bet they give you, you can end up picking up all the losers and leaving out all the winners.

    If you follow my records of my husband’s plays here: http://mylifeandart.typepad.com/wagering you will see that he “grinds his winnings” little by little every day. If you play erratic a game here and there, you are guaranteed to lose. It is the consistency and persistence will make the money for you in sports betting. It is similar to spreading your risk across many different stocks. The more plays (stocks) you have the more you spread your risk.

    Feel free to contact us if you want to learn more about sports betting. But it is way more serious endeavor than most people realize.

  29. The only way to defeat Bookmakers is by playing their own game. I mean it doesnt matter how expert you can be in certain sport, in the long run you will lose money because bookies have a mathematcal/statical system that make them unbeatable.
    So the only way to be profitable in the long run is by doing arbitrage or mixes handicap betting, it is the only way to become a bookmaker, put the odds on your side and generate profits for ever.
    We have 5 years experience as proffesional traders so any doubt just drop me a line.
    Regards,
    Diego

  30. This is ludicrous comparing the market to a season in football/baseball/basketball. The only thing in common is folks get attached to teams/players/styles folks get attached to stocks.

    Investing will and always will be the true form of investment, you can always win money in investing. You can not always win money in gambling or sportsbetting. The author is trying to do an over simplified analogy of the stock market without an overall understanding. Once he invests several 100k into it, perhaps he can have a grasp. But i see a lot of sheep rationalizing his view because they too, do not understand economics.

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