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.

Economics and a View of Life

I’ve found it interesting to think about how people organize their lives. I feel that most of us, myself included to this point, choose a particular view on life because of the events that have shaped our lives. We learn from experience and most of our experience tends to be in an area that we are drawn to as children or young adults. I know that is certainly true of myself.

I find myself drawn more and more to economics as a means of explaining the world, even if it’s just a framework for hanging knowledge on. Recently I drew out a little diagram that indicated how economics, as a viewpoint, shapes the other areas that I spend my time working on. Marketing, which I do for Click Consulting, is very directly related to economics for the simple reason that economics studies the spread of money and marketing tries to redirect the flow of money. Investing, my other business love, is directly related to economics because investing is the attempt to purchase assets before money flows to them and then sell the assets after people with money want it.

In many ways all of my interests, from psychology and biology to architecture and engineering, are directly related to economics. I picked up a book the other day called Butterfly Economics about how economic theory is mostly flawed because it looks at markets more like physics problems than biological, chaotic problems. The math and movements are less like Newtonian motion (even Brownian motion) and are in fact more like the evolution of animals or bacteria. I have found it funny that most kids believe all the random things they learn in general education classes have no use to them. Everything, if you’re willing to put it all together, is connected and influences each other. Knowing a little bit of a lot allows you to see a lot of casual connections you wouldn’t otherwise see or even have any inkling to see.

I am beginning to understand that I can learn a lot of things, even things that I would have never had any interest in, if I am willing to relate everything back to economics. I feel that economics is the study of how people place votes on what they value. It’s almost like psychology but with a voting mechanism. And in many ways I’ve found the models created to be interesting ways to look at the world. The idea that raising prices during a crisis is the humane thing to do seems counter-intuitive at first. Why would you take advantage of someone like that? In fact, it’s the exact opposite. By raising prices, the shop owner is actually ensuring that everyone gets a little bit instead of a few people hoarding. He might get lucky and might get a lot of money for his troubles, but there is always the possibility that there will be no recovery and the money he got for the goods is worth nothing. We all get paid based on risk and the value of the goods was have on hand. So I can learn psychology both directly through examples like the one above (both how the shop owner reacts, the people react, and the actions they take illuminate a lot about their views of the world) and by seeing how psychology models of the world match up to economic models of the world.

It will be interesting to see how an economic view of the world, looking at how people transfer value to each other, affects the ways I interact in the world. I wonder how your own model affects your view of the world, how you learn new knowledge, and how you interact with other people.

Investing and other tidbits

I believe in a lot of ways that business and investing are different sides of the same coin. In business, we’re always trying to approach the right set of customers with the right product at the right price. In investing, you’re trying to find the right industry, then the right company that is targeting the right customers with the right product at the right price, and then you have to try and buy that company at the right price for yourself.

I started investing in the stock market when I was twelve and did it all through high school. When I reached college I realized that I didn’t have time to really understand what was going on. That’s one of the tricks to making money consistently in the market in my view. You have to really understand mideconomics. Most people are split into macro or micro economics, but in my view both focus the attention on cycles that are too short. Microeconomics tries to guess which company is going to be best over the next quarter because of the customers they have tomorrow. It looks at internal company metrics and industry-wide comparisons. Don’t get me wrong, i believe each of these metrics are quite important, but they don’t tell the whole story. See, a huge part of being successful in investing is picking the right industry as I said before. if you have the best company in a bad industry, you have a bad stock. But if you have a marginal stock in a great industry, you have a good stock. Macroeconomics has a tendency to, amazingly, also become very shortsighted. People start looking at movements in the Fed as the holy grail for what to do tomorrow. The implication is that the macroeconomic decisions will affect us right now so we have to react or we’ll be left behind.The macroeconomic view also fails to really tell us which industry to invest in unless the industry we select is somehow tied directly to macroeconomic trends. Again, don’t ignore macroeconomic information, but don’t make it your main priority. Here’s a crazy stat to think about: we’re heading into a recession so our economy is going to drop somewhere between 1-5%. So we still have 95% of our economy. Why are so many people worried? Do we all believe we’re in the bad 5%? Business still has to get done and certain companies are going to take advantage of everyone else’s fears and nervousness.

This is where my idea of the mideconomic view has served me well. I try to take both the micro and macro economic views, but I also try to find one further view that few others seem to follow. I try to find where the game changing industries are going to be. It seems that the industries with the most innovation are the ones that tend to make it over the long term. That’s why, for example, I would recommend investing in solar eventually, once the market settles down a bit. There are absolutely amazing innovations being made that will cause solar to become a viable power alternative over the next few years. Here are a few examples: Rensselaer Polytechnic Institute Researchers found a way to make solar panels non-reflective and thus absorb sunlight from any angle, greatly increasing the light uptake and conversion. In Spain, researchers have found a way to make solar cells take up sunlight from either side, again decreasing the cost of harvesting sunlight. The real trick to investing by way of mideconomics is understanding that you are actually investing for 5 years or more out. It’s not long term investment in the traditional sense where you figure that a company will be around forever so they’re a good investment, but rather an educated bet on both an industry and then a company inside of that industry because of the macroeconomic, cyclical view of the future and the microeconomic, industry and company view. How does the individual company invest in the future, what kind of links do they have to established researchers, and how well do they manage their internal resources?

In other news and tidbits, here are some interesting links. “A new study published in the journal of Minerva Cardioangiologica reveals Pycnogenol, pine bark extract from the French maritime pine tree, reduces jetlag in passengers by nearly 50 percent… lowered symptoms of jetlag such as fatigue, headaches, insomnia and brain edema (swelling) in both healthy individuals and hypertensive patients”, read more here. Elsewhere, it appears that we can use rocks to solve global warming. Part of the techtonic plates, about 20 miles underground, react with CO2, so we could be piping CO2 from powerplants down there in the near future. Read more here.