How I know that the betting markets are inefficient

Is the betting market efficient?

You have probably read countless studies that show how efficient the betting market is. They can sound pretty convincing and, in general, I’d say they are right. You will also see how the financial markets are efficient for similar reasons. Again, I’d say that was sort of right. Note my declining confidence here.

If my lack of enthusiasm is starting to show, then I’m glad you are hearing that, as I’ve seen first-hand how both arguments are flawed. I’ve worked hard over many years to explain it, but much more important than that, I’ve put a lot of my own money behind my views to prove that, in fact, markets do not work the way some people think.

It’s now over 20 years since I opened a Betfair account and started betting for a living, or trading or whatever you wish to call it. It doesn’t matter; I’m still doing it.

Thank you, Mr Buffett & Munger

I think most people often feel that something isn’t quite right with the world.

My first inkling that I was on the right track was when I invested in Berkshire Hathaway and started listening to the musings of Munger and Buffett. They would often talk about how human nature was one of the reasons for their astonishing success and how behaviour, especially under uncertainty and stress leads to mistakes.

It would take years before I truly understood this.

Value betting and efficient markets

I started my ‘career’ in value betting and arbing.

Arbing just exploited price differences between bookmakers, and then betting exchanges. As the range of activity and sports grew, I started pricing up more and more markets to test how efficient the markets were. I came up with various models for different sports, football being the first.

When I started to look at racing markets, I started to realise odd things were happening. The market was efficient but also inefficient at the same time.

I remember looking at a two-runner group race at Goodwood. Both horses had won over course and distance, were equally rated and, for a short time, the same price. But from there, the prices diverged dramatically. There didn’t seem to be much logic in that and it resulted in the situation that one price was too short and one too big.

It was evident to me that in five minutes, the chance of a horse improving or there being new information couldn’t change the price that much, therefore, it must be inefficient.

But if you looked at it from a market perspective, then from a statistical standpoint, the price on one cancelled out the other. The market was displaying efficiency at a top level, this was because one won and one lost the odds of that happening were 100%. But on an individual level, the market was anything but efficient.

For the record, the horse that drifted like a barge won.

Trading and efficient markets – String theory

Trading markets are also efficient by many academic standards. At any one point, they reflect the value of discounted information.

I generally wouldn’t disagree with this concept, but where it falls over is that it’s not an accurate description of how you profit when you trade. Again, describing a market is very different from profiting from it.

Imagine a piece of string stretched out. You have the start point, the endpoint and the path it follows between those two points. The market, in the aggregate, is efficient at each point. As we move towards the final price, we get more efficient as new information is discounted.

But the market doesn’t work like that. It’s more like a tangled piece of string meandering up and down before it reaches that endpoint. A mixture of opinions, emotions and a whole gamut of other stuff. It’s slightly chaotic at times.

The difference in length between the ‘efficient’ piece of string and the one that is more representative of the market, is where the value is created when trading. That is where the profit is coming from.

That’s the reality of trading. You profit from uncertainty, not efficiency.

So that’s the theory; what’s the reality?

Of course, it’s pretty easy to pick holes in any of the points I’ve made above. They are just concise summaries of my observations over a large number of years. So they are wide open to individual points being argued about. It’s impossible for me to convey all my knowledge over many years in a concise form.

But there is one fact that isn’t open to any level of interpretation. Beat the market for one year could be a fluke. A few more years of outperformance could also be possible if it were luck alone. But I’ve now been doing this for over two decades!!

After so long in the markets, I find that my opportunity is limited only by the scale of the markets and the number of opportunities they present. Those things are out of my control regarding scope and scale, but those opportunities are ever-present.

Human arbitrage

Of course, things are not that simple because everybody would rush in and correct inefficiencies, wouldn’t they? But I’ve watched on in these 20 years and watched people fail repeatedly to do that or repeat the same mistake again and again.

So inevitably, I’ve wanted to know why to fill the gaps in my knowledge. The answers were surprising. They came to me in two critical ways as first, both centred around psychology.

To cut a long story short, people view the world through their own ‘filters’ and may not see the same as you. People also find it very hard to change their minds; they prefer to reach a conclusion and look for things to justify that view, dismissing any evidence that contradicts it.

These things finally allowed me to fill the puzzles I saw in the market. I had discovered the joy of cognitive biases, and I found more of these over time and deeply expanded my knowledge of them. Suddenly I could see them everywhere in the market, in life and on the field of play in sports. It was a revelation.

If you want to be in the best place, you need to have some intellectual intelligence and some emotional intelligence. Too much of either, and the biases really become strong.

I’ve faced a lot of prejudice with what I do. But just because you don’t understand something doesn’t mean that you shouldn’t make the effort to learn why.

But in an industry that is renowned for bad behaviour, it doesn’t surprise me any longer when people just don’t get it. But you know what? Difference of opinion makes a market, and specific biases create additional opportunities in those markets.

I sort of dread the day when the more general penny drops. But after twenty years, I don’t think it ever will; I could just be onto something here!!!

Putting it all together

I’ve now settled into this pattern of not only trying to work out what the price should be in the market but also trying to work out how the market will react to it, and it’s a game that I immensely enjoy.

I’ve tried to distil this knowledge into several blog posts and videos that give you a good summary of roughly what you should be trying to do. But realise that each person will see this slightly differently and have somewhat different approaches and abilities. You know what? That’s what makes a market.

But in general, the majority of the market will not be trying to do anything clever. If you just nudge things slightly in your favour, you should be able to gain an edge over most participants. Doing that has worked well for me for two decades.

The future

When I first started doing this, I worked really hard, as I didn’t know when the opportunity would end. It never did, so I’ve realised that I have more choice over what I do than I thought.

Despite all I do, I’m not immune to changes in the market, either in terms of participants or structure. So I constantly fiddle with strategies, approaches and assessments of markets. Over time I’ve lost my fear of losing my edge as I feel I understand why they exist, and therefore if something shifts, I can adapt.

But one of the traits I’ve learned to adopt is to be constantly looking out for opportunities, as they are everywhere. So whatever you think about the markets, the industry or the prevailing landscape. There are nearly opportunities.

It’s up to you to find them.

But also understand, if the market is fully efficient it would have been impossible for me to have existed, yet I do. I believe I’ve shown beyond doubt, that if you look in the right places, you will find inefficiency and with it, opportunity.