Gambling vs Investing

Recently I stared up a website with my roommate. He is a gambler who makes bets on basketball and football games. The site was set up to let him make predictions on the games and post them for all of his friends to see. While I don’t gamble, learning about sports betting has caused me to see the connection.

A few days ago I realized that sports betting is very similar to investing in options, a derivation of investing in equities. To set up the connection, I’ll explain how both stocks are traded, simply, and how sports bets are played. In sports betting, a handicapper (someone who knows a lot about the sports) makes a prediction about who is going to win and by how much. Then gamblers place bets on whether or not he is right. I have very rarely seen handicappers get the numbers right consistently. More often than not one team blows the spread out of the water. So that means that the reality of sports betting is that you’re just going head to head against the bookie’s handicapper. Do you have more information about the game than he does? Consider that most handicappers are predicting the outcome a fifty to a hundred games a day. Is there something that he overlooked that could significantly affect the performance of one of the teams? And, when you consider that almost every bookie has the same odds (set by Vegas) so they can stay competitive with each other (and so they don’t have to try and predict the outcomes themselves), you’re really only competiting again one guy’s best guess.

Now lets consider equities. What causes stock prices to move? Almost exclusively it’s profitability in some form. News that could affect future profitability will cause a stock to move up or down. Quarterly reports that explicity say last quarter’s profitability move a stock up or down. So ultimately if you buy a stock, you’re predicting that the company will be more profitable in the near future (if you hope to flip it) or will be massively more profitable in the long term future  (if you plan on holding for the long haul). Instead of having one bookie that determines the price, millions of people buy and trade their opinions each day. Instead of being smarter than one guy to win, you have to be smarter than a crowd to win.

There are two crucial differences between stocks and sports bets. One is time. Sports bets are timed events in which you make a bet, it gets played and you’re either a winner or a loser. Owning a stock that doesn’t perform as you expect still gives you the option to hold it and sell it later once it’s profitable. This is where options come in to play. Options are almost always time sensitive. They expire at a certain point and if they’re not ‘in-the-money’ or correct, then they expire with little to no value.

So looking at stocks/options and having the betting lines set by millions of players, it at first seems significantly different from sports betting, but think again. Just like individuals, entire crowds get swayed. How else do you explain the fact that the DOW traded above 14,000 in mid 2008 despite the fact that the real estate bubble (underlying much of the current crisis) burst as early as March 2007? Shouldn’t a few people have noticed and started gambling against common knowledge?

I believe that the basis of gambling and trading stocks is the same. You don’t have to beat some mythical standard to win, you just have to beat the guy (or millions of guys) across from you. You have to realize that most people are incredibly uniformed, so by having the discipline to only play the few bets where you have a massive knowledge advantage (and then managing your money well), you can make significantly better than average returns on your investment, whether it is sports betting or investing.

As a side note, I still don’t bet on sports. I don’t have any better knowledge than anyone else, despite the fact that my roommate does quite well at it.