From a reader comes thoughts on intrade.com
intrade is a prediction-based website, where they offer essentially “bets” on outcomes. each trade matures at either 0 or 100, a negative outcome and a positive outcome to the event/trade in question, respectively. if at the extreme, markets and bets such as these were perfectly predictable, then the spread between the starting point of the bet and the ending point of the bet would have zero variance. in other words, each bet would be binary: if we could predict with 100% certainty that the Dow would finish above 12,000 by the end of July 2008, then the bet would start at 100 (actually slightly less given the time value of money) and mature at 100, as each player’s minimum bid would be essentially 100. thus a unary outcome - bets finish where they started as everyone has 100% certainty on the outcome, as markets would then be 100% predictable. conversely, if markets and bets such as intrade offers were not 100% predictable, then the variance of the price should be all over the place, which is exactly what you see at intrade. bets start at 20, move to 90, then mature at 0. some start and stay at 50 forever, only changing within a couple of days of the bet’s maturity, as certainty emerges. i recall the 2004 election, where Bush was given up as the exit polls showed him losing, and the intrade bet on Bush to win I believe hit 20, only to mature at 100 a few days later. So intrade’s bets essentially proves the unpredictability of markets and events: bets often start at 50 (zero prediction as it is equidistant), often move 90+ points as they swing from one outcome to another, but rarely do they start and finish near an outcome, given the complex system on which one is betting. this again all essentially proves that NOTHING is predictable in a statistically significant basis.
Thanks.
June 30th, 2008 at 10:49 am
[...] Covel on the prediction markets. Bottom line: Nothing is predictable, so stop [...]
June 30th, 2008 at 10:15 pm
This is the same reason why I became so disenfranchised with economics at college. I finally began to see economics as a big bunch of crap — all people rationalizing their theories after the fact. But, when given a set of circumstances RIGHT NOW, no one could ever say with any certainty or consistency what was going to happen next (in any situation, economics or otherwise). I believe economic theory to be futile. And, as is the case with any complex system (markets, economies, weather, bees flying around), prediction is not possible with any statistical reliability.
There is also an interesting parallel in trading to epidemiologic studies (i.e. studies of how diseases spread in human populations), many of which use case-control methodology. This methodology looks at individuals with the disease and those without. It then identifies factors in common amongst those with the disease (i.e among those with emphysema, 77% smoked at least 2 packs a day for 10+ years). The result is that you can speak with a certain level of statistical confidence about a population of smokers (a population that smokes a lot with have more adverse health outcomes of any type) — BUT, given an individual smoker, you could never predict with any statistical confidence what that individual’s ultimate health disposition (emphysema, no emphysema, stained teeth, whatever) would be.
As in trading, there are too many interdependent factors to make predictions on an individual stock. But if you look at populations of stocks with certain characteristics (or futures or whatever), you can see that general patterns (i.e. trends) repeatedly emerge throughout that population. You cannot predict when they will occur, but you can set up circumstances (ie through your complete trading system) that greatly increase your probability of capitalizing on them if/when they do.
And you do that, of course, through money management, discipline, risk control etc…..