Stock Market Trend: Similarity to Horseracing Market

[linrom1]

I posted this on a stock board where no one seems to understand the similarity of stock market to horseracing, nor the context of my post. In fact, the arguments one heard were similar to the ones made on this board about racing, "how handle was up" ;and thus, they tend to conclude that stock market will never change?

I have a suspicion that most sentiment readings are now less useful, but traders fail to note that the game is changing. The so called "dumb money" has , for most part, left the game, leaving much more seasoned traders to engage each other. I have long suspected and noted the many similarities between stock market and horse racing market---- only few non-racing fans are aware that horse racing was the most popular sport in 1940s. But change is inevitable and it would be impossible for today's typical NASCAR and slot machine fan to patiently study mathematics and rigorously pour over odds and probabilities of winning "bets".

The biggest change is going to be that the stock market will become almost exclusively a "parimutuel" sport, with all parties involved losing money except for those that make commissions or fees based on payment of expenses used in operating the market. This is easy to recognize in horse racing since it is rudimentary understanding of the sport that all parties are gaming a system where 20% is taken out of the pool as expenses and horsemen purses. To overcome this handicap, you need odds that compensate for this. But, this simple premise is not understood in the stock market. Majority playing in the market fail to even consider this basic premise as something that will affect their future returns. Yet fewer realize that they pay Wall Street salaries and expenses. It's easy to overlook it when market is inflating; but, not when market is contracting.

While this might sound preposterous, I am going to venture that almost all market players are going to lose money going forward because when market no longer inflates, traders will have to fight for less than 100% of the money they put into the game, but there are no odds to overcome this handicap.

Recently Blomberg News reported that Goldman Sachs returned to profitability after the broker raised fees that it charges its customers. Oh boy, who would've guessed!

[PaceAdvantage]

The market goes up and the market goes down. Are you saying it's never going to go up again?

And shouldn't this post be moved to off-topic?

[garyscpa]

The market goes up and the market goes down. Are you saying it's never going to go up again?

And shouldn't this post be moved to off-topic?

I'm afraid that if I vote yes, the market will go down.

[PaceAdvantage]

As long as there is greed, the market will always find a way to go in the opposite direction...

If the market only went in one direction all the time, we'd all be rich and there would be no market.

[garyscpa]

As long as there is greed, the market will always find a way to go in the opposite direction...

If the market only went in one direction all the time, we'd all be rich and there would be no market.

No, we'd invest more and get richer. :D

[Dave Schwartz]

No, we'd invest more and get richer.

Just like with tulips.

[garyscpa]

Just like with tulips.

Exactly. :)

[robert99]

Commenting on what was posted:

[I have a suspicion that most sentiment readings are now less useful, but traders fail to note that the game is changing. The so called "dumb money" has , for most part, left the game, leaving much more seasoned traders to engage each other.]

Not all stockmarket is trading.
Many are very well aware of constant changes.
On the stockmarket no gain or loss is made (except) for fees until you sell/buy - you have time as a friend. In horseracing, once the race is run that is it. If stock gains are made by fundamentals ie companies increasing earnings then all can win. If you get out before the usual slump you can still win. In racing, if you pick the wrong horse - you lose. There are no bubbles in racing though.
On the stockmarket the seasoned traders have largely been replaced by super fast machines that cream off fractions. The racing markets are expanding worldwide by internet at the same time they may be contracting in individual countries. There is an increasingly huge amount of dumb money left worldwide. Most private old style stockmarket trading and Wall St is dumb money - following the tails of a trend long after others have cleaned up.

[But change is inevitable and it would be impossible for today's typical NASCAR and slot machine fan to patiently study mathematics and rigorously pour over odds and probabilities of winning "bets".]

Not likely but not impossible. Sports and racing are one of the few areas where understanding and superior knowledge can improve the likelihood of a profit. There are billions of punters in China that have far better mathematics than the average American.

[The biggest change is going to be that the stock market will become almost exclusively a "parimutuel" sport, with all parties involved losing money except for those that make commissions or fees based on payment of expenses used in operating the market.]

[This is easy to recognise in horse racing since it is rudimentary understanding of the sport that all parties are gaming a system where 20% is taken out of the pool as expenses and horsemen purses. To overcome this handicap, you need odds that compensate for this. But, this simple premise is not understood in the stock market. Majority playing in the market fail to even consider this basic premise as something that will affect their future returns. Yet fewer realise that they pay Wall Street salaries and expenses. It's easy to overlook it when market is inflating; but, not when market is contracting.]

The stockmarket only exists to "make" money. If it can't make money for any investors they invest elsewhere. Every investor is well aware of the drag that fees induce - and actively minimises them whenever possible. They are totally aware of fees. Person to person internet betting is the growth area of sports and racing betting and the take out varies 2-5%. Even on the PM rebates are negotiated.


[While this might sound preposterous, I am going to venture that almost all market players are going to lose money going forward because when market no longer inflates, traders will have to fight for less than 100% of the money they put into the game, but there are no odds to overcome this handicap.]

For decades only an estimated 4% of racing bettors and 5% of stockmarket traders have made any consistent money and 2% any worthwhile money.
Traders don't trade unless they can have a chance of making money. There are odds in your favour of inside information and share ramping etc. For every scam exposed they have another dozen up their sleeves. Bad trades go on the client account - good trades on the personal account.

[Jeff P]

A while back I stumbled upon some articles written about Ed Thorp (author of Beat The Dealer) and his application of statArb for grinding out returns in the market.

Trading, Ed Thorp and Fortune's Formula:
http://www.tradingmarkets.com/.site/stocks/commentary/editorial/Trading-Ed-Thorpe-and-Fortunes-Formula-80258.cfm

IMHO the articles are a fascinating read.

-jp

.

[Valuist]

First off, there is no guarantee stocks have to go up. Many don't deserve to go up. And one does not have to only benefit when stocks go up. Shorting is a great hedge in a bear market.

As for fees, commissions are down considerably. Years ago, people were taught to "buy and hold". But with the flow of information much greater, and the cost of commissions significantly lower than in the past, buy and hold seems like a very lazy, haphazard approach.

[lansdale]

A while back I stumbled upon some articles written about Ed Thorp (author of Beat The Dealer) and his application of statArb for grinding out returns in the market.

Trading, Ed Thorp and Fortune's Formula:
http://www.tradingmarkets.com/.site/stocks/commentary/editorial/Trading-Ed-Thorpe-and-Fortunes-Formula-80258.cfm

IMHO the articles are a fascinating read.

-jp

.

Jeff,

Thorp is a fascinating character. It seems as though he was the original author of what later became the Black-Scholes model, which won a Nobel Prize for a couple of the principals of LTCM, a group which he was prescient enough to refuse to join. Still, he became immensely wealthy using the model, or his modification of it, so perhaps that was some consolation.
But, I'm guessing you've probably read 'Fortune's Formula', so none of this may be news to you.

Cheers,

lansdale

[stuball]

Thanks Jeff for the heads up on those articles. I read them
and was fascinated by them. There are 6 in the series...
I went back and read them again. It absolutely shows that
you can make money on good stocks and bad stocks.
Achieving a zero balance in the stocks according to the articles must take some very sophisticated programming..
I repeat I was really into the idea and immediately thought of
Betfair....how it could apply.

Stuball

[Jeff P]

The similarities between the market and racing and what Thorp and people like Benter and the late Alan Woods accomplished are striking. Benter and Woods created their "models" for racing. Thorp's "models" were created for the market. However, the market and racing are both in fact "markets."

Which begs the question: What do you need to do to successfully attack a market?

My own educated guess is that there are steps you can do to facilitate success in both types of markets - and that the keys to success in both racing and the market are more similar than most would think.

IMHO, in the simplest of terms, these are the basics:

1. Create a model that captures the essence of what is actually happening in your chosen market space. The model should be fully capable of making you aware whenever (to borrow a phrase) a statArb (edge) situation is staring you in the face.

2. Create a plan for exploiting your model. This should entail: 1. Categorizing and rating the types of plays and strength of plays produced by the model. 2. Defining the types and sizes of bets to be employed along with the precise situations you will employ them in. 3. Recordkeeping.

3. Execution - Take the very first statArb (edge) opportunity that comes your way, make your bets (or trades), and record your results. Then repeat going forward an almost infinite number of times. If you created a viable model in step 1 above and your plan of execution (step 2) is well thought out then you WILL grow money as you get into the long run over time.

Simple right?

-jp

.

[lansdale]

The similarities between the market and racing and what Thorp and people like Benter and the late Alan Woods accomplished are striking. Benter and Woods created their "models" for racing. Thorp's "models" were created for the market. However, the market and racing are both in fact "markets."

Which begs the question: What do you need to do to successfully attack a market?

My own educated guess is that there are steps you can do to facilitate success in both types of markets - and that the keys to success in both racing and the market are more similar than most would think.

IMHO, in the simplest of terms, these are the basics:

1. Create a model that captures the essence of what is actually happening in your chosen market space. The model should be fully capable of making you aware whenever (to borrow a phrase) a statArb (edge) situation is staring you in the face.

2. Create a plan for exploiting your model. This should entail: 1. Categorizing and rating the types of plays and strength of plays produced by the model. 2. Defining the types and sizes of bets to be employed along with the precise situations you will employ them in. 3. Recordkeeping.

3. Execution - Take the very first statArb (edge) opportunity that comes your way, make your bets (or trades), and record your results. Then repeat going forward an almost infinite number of times. If you created a viable model in step 1 above and your plan of execution (step 2) is well thought out then you WILL grow money as you get into the long run over time.

Simple right?

-jp

.

Jeff,

From reading some of the material on your site, it seems that this is what you're already doing very well. However, I don't know if it's accurate to say that racing in general, can be compared to the financial markets - isn't each race is its own market, an independent trial?

You mention Benter and Woods - as you know, one of the powerful tools they were using, which Thorp still uses, is Kelly betting. It seems to me one of the great advantages of Benter's logit model was that, by transforming a partly subjective judgment into a quantitative assessment, it was able to incorporate Kelly.

I remember that you once played blackjack seriously, as I still do, and wonder if you ever came across the name of blackjack authority Don Schlesinger. If not, he's best known for developing a measure of blackjack game evaluation, an adaptation of the Sharpe Ratio known as SCORE, which is widely used by blackjack pros. Although blackjack is amenable to Gaussian models and horseracing (like the financial markets) is a non-Gaussian game, I wonder if he might have some ideas on how Kelly might be adapted to varying handicapping styles and techniques. I sometimes have online exchanges with him, and I know that he has a relationship with Thorp, who likes to stay in touch with blackjack. Maybe we could get him involved too ;-). Let me know what you think.

Cheers,

lansdale

[Jeff P]

Lansdale,

The first time I read about SCORE I remember thinking "Are they serious? Why would anyone go to that much trouble to rate a playable game?"

Of course looking back now I realize how foolish I was back then.

By way of comparison - I'll admit to putting in a lot more work finding playable races today than I ever would have put in back then finding a playable game of 21.

-jp

.

[lansdale]

Lansdale,

The first time I read about SCORE I remember thinking "Are they serious? Why would anyone go to that much trouble to rate a playable game?"

Of course looking back now I realize how foolish I was back then.

By way of comparison - I'll admit to putting in a lot more work finding playable races today than I ever would have put in back then finding a playable game of 21.

-jp

.

Jeff,

Yes, SCORE really is key, not only for checking out games, but probably more significantly for determining an optimal bet ramp - an area of BJ theory which has really been developed in the last decade or so. One of the most interesting things about SCORE is how often the advantages it reveals are counterintuitive - the game you thought looked bad really isn't, and vice versa. Since many of the best games are outside the USA, it's also very useful for evaluating games with sometimes very strange (and profitable) rules.

Another reason I mention Don is that he worked on the trading desk of Morgan Stanley for a number of years, following the people mentioned in Thorp's article, and did quite well there. Although retired, he continues to train MS personnel in derivatives trading (a somewhat dubious profession at the moment!) and lectures around the world on the subject. Thus, statistical arbitrage is a subject he understands very well.

Cheers,

lansdale