Three anecdotes about having an edge but only in illiquid markets where the derivable value is limited:
1. Back in 1991 a friend of mine had the following market-beating insight. He was watching Freddie Mercury on TV a few months before he died; at this point it was not publicly known he was ill with AIDS (nor even, bizarrely, that he was gay—I think all was only revealed just before he died).
My friend said “He’s not looking well...” and then made a brilliant inference: ”...so Bohemian Rhapsody will be the Christmas No. 1 record this year, then”. (In the UK anyway, a big deal is/was made about which single would chart at no. 1 on Christmas Day, and you could even place bets on it.) And so it came to pass—Freddie Mercury unexpectedly died a few weeks before Christmas, Bohemian Rhapsody (dating from 1975) unexpectedly went to no. 1, and my friend kicked himself forever more about not placing a bet on it—bookmakers would have offered odds of 100-1 or even 1000-1.
The catch though, from a couple of times I’ve tried placing big bets on unlikely events, is that (most) bookmakers don’t seem to accept them. They might accept a $100 bet but not a $1000 one on such odds. They suspect you have inside information. (The same happens I’ve heard if you repeatedly win at roulette in some casinos. Goons appear and instruct you firmly that you may only bet on the low-stakes tables from now on.)
Freddie Mercury’s unhealthy appearance was public information. If the market in bets on Christmas no. 1 records were liquid enough, thousands of others would be considering the third-order consequences of such information & making similar inferences, the odds would be rapidly changing, and my friend would have lost his edge by the time he placed his bet.
So while he could have beaten the illiquid market, he wouldn’t have made much in expectation—maybe not enough to justify the time & risk—and conversely he couldn’t have beaten a liquid market which would accept big enough bets.
2. Similarly, another friend of mine worked for a while with a tech startup that was arbitraging between betting exchanges (like Betfair) on which ordinary people can lay odds as well as place bets. As a result of which, different exchanges often show somewhat different odds on the same event. After much development and testing, the startup realised that though they could reliably identify & arbitrage these odds differences, they could only make dollars per hour doing so, not thousands. There wasn’t enough liquidity on the betting exchanges. The wronger the odds someone was laying, the smaller the bet they’d accept. So the startup closed down.
3. I’ve been trading equities since 2006 on various index derivatives, in very large amounts. I have expertise on one niche area, involving a lot of data & programming, and beat the market for some years with it, until the effect in question went away (as it was already known about, albeit quite obscure).
Recently I’ve found a derivative of a particular index that seems to have excess risk-adjusted returns in certain bets on it, so have been trading it for a while. Again I’ve had to source and estimate and crunch large amounts of hard-to-obtain historical data, writing my own software to manipulate it. But the inefficiency is probably only because this derivative is quite illiquid. Some days I’m doing a significant fraction (even a quarter or a third!) of the whole day’s trading on it! (Though I am betting very large amounts.)
So I reckon I probably am beating the market, but only because I’ve found a sweet spot where there’s extra money to be made, but not enough for more than a few others to do so too. I’m grabbing a large part of the edge to be had, by using kinda public but hard-to-get information. If the derivative were more liquid, others would be finding similar things to me. If it were less liquid (like Christmas no. 1 bets) I couldn’t place big enough trades to be worthwhile.
(There is also extra risk from the limited liquidity (e.g. of slippage when stopped out) which might reduce returns a lot in an extreme situation—though I suspect not enough to remove my overall edge. The risk needs very careful handling.)
The catch though, from a couple of times I’ve tried placing big bets on unlikely events, is that (most) bookmakers don’t seem to accept them. They might accept a $100 bet but not a $1000 one on such odds. They suspect you have inside information. (The same happens I’ve heard if you repeatedly win at roulette in some casinos. Goons appear and instruct you firmly that you may only bet on the low-stakes tables from now on.)
Right, the EMH doesn’t fully apply when sharks can’t swoop in with bets large enough to overwhelm the confederacy of Georges. The odds bookies offer are a hybrid between a market and a democracy.
Thanks for sharing your experience—the third section in particular is really interesting. Relative to the central discussion: how much time and effort did you have to put in to find those edges, and do you think it was worth it? Would you encourage others to try and do something similar? Or is it more like a hobby?
It’s probably taken about a year’s full-time work (since 2006). Though I could have spent much less time by using a simpler albeit less effective version of what I do (as indeed I did initially) - just that I like improving it and investigating new things that might work. It is kind of a hobby, but involving a sufficiently serious amount of time and money and risk to be rather more than that.
I think it probably has been worth it, as I reckon the value of my edge is rather bigger than my time cost in salary equivalent, though it is hard to be sure because of the large variability in returns (not least because of two big crashes since I started).
But actually I wouldn’t encourage others to try. There can’t be many opportunities to beat the market, not many people can risk big enough bets to justify the time taken finding them, and there’s a lot to be said for adopting a simple mechanical system that takes little time; maybe just buy & hold (though maybe a bit fancier than that). Not sure it’s worth trying to pick stocks (I almost never do that) - just buy an index; though there is some fun to be had doing so, like picking horses, and kidding yourself you have special insight!
Thanks, good post.
Three anecdotes about having an edge but only in illiquid markets where the derivable value is limited:
1. Back in 1991 a friend of mine had the following market-beating insight. He was watching Freddie Mercury on TV a few months before he died; at this point it was not publicly known he was ill with AIDS (nor even, bizarrely, that he was gay—I think all was only revealed just before he died).
My friend said “He’s not looking well...” and then made a brilliant inference: ”...so Bohemian Rhapsody will be the Christmas No. 1 record this year, then”. (In the UK anyway, a big deal is/was made about which single would chart at no. 1 on Christmas Day, and you could even place bets on it.) And so it came to pass—Freddie Mercury unexpectedly died a few weeks before Christmas, Bohemian Rhapsody (dating from 1975) unexpectedly went to no. 1, and my friend kicked himself forever more about not placing a bet on it—bookmakers would have offered odds of 100-1 or even 1000-1.
The catch though, from a couple of times I’ve tried placing big bets on unlikely events, is that (most) bookmakers don’t seem to accept them. They might accept a $100 bet but not a $1000 one on such odds. They suspect you have inside information. (The same happens I’ve heard if you repeatedly win at roulette in some casinos. Goons appear and instruct you firmly that you may only bet on the low-stakes tables from now on.)
Freddie Mercury’s unhealthy appearance was public information. If the market in bets on Christmas no. 1 records were liquid enough, thousands of others would be considering the third-order consequences of such information & making similar inferences, the odds would be rapidly changing, and my friend would have lost his edge by the time he placed his bet.
So while he could have beaten the illiquid market, he wouldn’t have made much in expectation—maybe not enough to justify the time & risk—and conversely he couldn’t have beaten a liquid market which would accept big enough bets.
2. Similarly, another friend of mine worked for a while with a tech startup that was arbitraging between betting exchanges (like Betfair) on which ordinary people can lay odds as well as place bets. As a result of which, different exchanges often show somewhat different odds on the same event. After much development and testing, the startup realised that though they could reliably identify & arbitrage these odds differences, they could only make dollars per hour doing so, not thousands. There wasn’t enough liquidity on the betting exchanges. The wronger the odds someone was laying, the smaller the bet they’d accept. So the startup closed down.
3. I’ve been trading equities since 2006 on various index derivatives, in very large amounts. I have expertise on one niche area, involving a lot of data & programming, and beat the market for some years with it, until the effect in question went away (as it was already known about, albeit quite obscure).
Recently I’ve found a derivative of a particular index that seems to have excess risk-adjusted returns in certain bets on it, so have been trading it for a while. Again I’ve had to source and estimate and crunch large amounts of hard-to-obtain historical data, writing my own software to manipulate it. But the inefficiency is probably only because this derivative is quite illiquid. Some days I’m doing a significant fraction (even a quarter or a third!) of the whole day’s trading on it! (Though I am betting very large amounts.)
So I reckon I probably am beating the market, but only because I’ve found a sweet spot where there’s extra money to be made, but not enough for more than a few others to do so too. I’m grabbing a large part of the edge to be had, by using kinda public but hard-to-get information. If the derivative were more liquid, others would be finding similar things to me. If it were less liquid (like Christmas no. 1 bets) I couldn’t place big enough trades to be worthwhile.
(There is also extra risk from the limited liquidity (e.g. of slippage when stopped out) which might reduce returns a lot in an extreme situation—though I suspect not enough to remove my overall edge. The risk needs very careful handling.)
Right, the EMH doesn’t fully apply when sharks can’t swoop in with bets large enough to overwhelm the confederacy of Georges. The odds bookies offer are a hybrid between a market and a democracy.
Thanks for sharing your experience—the third section in particular is really interesting. Relative to the central discussion: how much time and effort did you have to put in to find those edges, and do you think it was worth it? Would you encourage others to try and do something similar? Or is it more like a hobby?
It’s probably taken about a year’s full-time work (since 2006). Though I could have spent much less time by using a simpler albeit less effective version of what I do (as indeed I did initially) - just that I like improving it and investigating new things that might work. It is kind of a hobby, but involving a sufficiently serious amount of time and money and risk to be rather more than that.
I think it probably has been worth it, as I reckon the value of my edge is rather bigger than my time cost in salary equivalent, though it is hard to be sure because of the large variability in returns (not least because of two big crashes since I started).
But actually I wouldn’t encourage others to try. There can’t be many opportunities to beat the market, not many people can risk big enough bets to justify the time taken finding them, and there’s a lot to be said for adopting a simple mechanical system that takes little time; maybe just buy & hold (though maybe a bit fancier than that). Not sure it’s worth trying to pick stocks (I almost never do that) - just buy an index; though there is some fun to be had doing so, like picking horses, and kidding yourself you have special insight!