How Bookmakers Create their Odds from a Former Odds Compiler

This post originally appeared at www.daily25.com and has been reposted here with the permission of Steve from the Daily25 blog. It is written by Matthew Trenhaile, who has worked as an odds compiler for many years and is now on his own taking on the bookies. You can follow Matthew on twitter @CrazedAlchemist and he also has his own blog. Over to Matthew.

Matthew’s Background as an Odds Compiler

My name is Matthew Trenhaile, and I have worked for six years at the UK Sport Spread Betting division of the IG Index, as an odds compiler. Steve was kind enough to allow me to utilise his blog to show my abilities in writing, through a series of articles from someone who has actually worked with a major bookmaker and in the industry. To begin with, I’d like to address some phrases I am going to use continuously throughout these articles, as the names and nicknames for different situations are different from nation to nation;

Jolly = Favourite to win

Rag = Underdog to win

 Sharp = Smart punters

 Square = Losing punters

 Books = Bookmakers

 Bowler = An account in another person’s name, used to place bets

 When I describe my odds it will be in decimal (European) odds, and when I am referring to an amount of money, the currency will be Pounds (UK).

A lot of the articles I have read lately, in addition to television pieces, have generated a lot of debate. This is completely fine by me, as long as it has good intentions. These are my opinions, and I respect the ones of others as well.

An Evolving Betting Industry

In all of the following and future articles, I’ll be attempting to tackle subjects from a past, present and future perspective. To begin, I will take a look at odds compiling and how this has changed over the years, with my main focus on the last fifteen years. I will also be looking into how bookies copy their prices off each other, which is a topic that is relevant in the industry today. The industry concerned with Spread Betting stands responsible for every change that is of any significance in odds creations of the last 25 years. This is also where my perspective and experience comes from.

I would advise readers that aren’t familiar with Spread Betting to read at Sporting Index’s site and go through their training section to get an idea of what’s involved in this. In sports Spread Betting you could oppose an outcome before you could lay on Betfair, and you could bet in-running online at the spreads before any of the fixed odds bookies. The doomed to be a failure product Extrabet, with the dreaded close out button, was also created by IG Index. Even though this doesn’t necessarily mean that I am extremely great at compiling odds in comparison with others, it definitely means that I was at the centre of advancements in technology in the sport betting industry. This was the reality back then, and the sports spread betting industry is still the leader. This goes through the employees, who devise the models of other bookies. It can also happen through firms such as Sporting Solutions, a spin-off from Sporting Index, where in-running prices towards bookies is the product. It is a clever move by fixed odds bettors to take a look at the spread betting firms prices, as their secondary check or backup before actually placing their bets.

How Odds Compiling Works

Databases, Statistics and mathematical models all play an increasingly large role in compiling odds, rather than personal experience, intuition and feel. When I worked, I was fortunate enough to work alongside odds compilers that worked in the “old” way, and had watched thousands of hours of horse racing, and could distinguish the smallest of nuances of how the horse was ridden and the strategies of the trainers. I also worked with people who broke down sports into their fundamental inputs and turned those inputs into probabilities. This was done before and ruing races.

Initially, odds compilers were split on the prospects of Betfair, and especially on its uses with regards to compiling prices. When I started working, Betfair had only just reached liquidity levels that were significant, and couldn’t be ignored due to the fact of the increasingly large number of arbitrage bettors. After 6 years, we priced all horse racing products after our Betfair API, only using one person to oversee that the process was correct. This was an extreme contrast to back when I started, where we had one trader for every horse race and a room filled with 40 traders, even though the number of sporting events and matches were only a tenth of what we have now. As a result of being a subsidiary of a large financial firm, we were paid more than the remainder of the industry, and our resources topped every other bookmaker.  

Our resources were ploughed into trading at more events in-running and to develop more complex models to generate odds in-running, at an increasingly high rate. Generating these odds provided us with liquidity to the betting exchanges, and in turn generated a significant secondary revenue stream for us, in addition to providing these odds for our clients` sake.

Creating Statistical Models for Sports

The statistical odds compiling mostly consisted and originated from the counting of how often an event had happened previously. If we were compiling data from two football teams, we would look at how many times the home team had won in their last 20 home games, and how many times the away team had won in their last 20 away-games.  

This was prior to my time. In the old days, the edge was found by bookmakers, simply by studying the game more than the bettors and comparative odds knowledge. In other words, if a bookmaker found a 50% chance for a team to win its home games, and decided to put up a 1.85 odds, the bookie could trick the punter the next time, by putting up 1.75 odds. This is just because the bettor remembers what they played, and places the same bet the next time, regardless of what the odds are. The bookie will then have extracted value from the bettor, just by knowing what punters have played recently.

Odds compiling used to be more focused on the bets of the punters, rather than the probability of the outcomes. To this date, this is the very difference between bookmaking and punting. The bookies` job is to understand where money will flow, as opposed to the punter, who has to understand the probability of outcomes and recognise value.

In the world we live in today, the odds will reflect probabilities of an outcome more and more precisely, and is lesser concerned about the opinion of the public. The upspring of in-running betting is what stands behind odds compilation through mathematical modelling. This meant that it became too difficult for people and compilers to recognise prices in multiple markets for multiple events in-running, only through the use of a pen and some paper, rather than computers. Bookies had a need for automatisation, preferably through models.

The Possion Distribution for Modelling Sports

Almost every model for sports betting can be found on the internet, and have been available for quite some time. These models have been improved over a number of years, making the data greater. “Poisson” distribution led the way as the best football-model, because of its accuracy, as a result to being improved, in addition to being easier to add time decay to the inputs.

Poisson distribution is commonly used to create models of football.

Poisson distribution is commonly used to create models of football.

Each team has their goal inputs, and for every minute the game goes on, the model decreases. This means that as the simulation continues, the odds is recalculated, and changes a little bit every second, even when not significant enough to be visible. In the beginning, Poisson distribution was the only way, but we later changed to custom distribution for every league, and from goals scored to the expected number of goals based on shots.

These days, compilers measure the overall quality of the shots being taken, in addition to measure the individual players impact on the shots, to create a better understanding, and to create highly improved shots-models. Or are they actually doing this?

Every sport has a model that’s similar to this model, and all can be improved as the level, amount of information and data are made obtainable. The important point to focus on for bookies, is whether or not they wish to go down this road. Do they go through with the payments to secure this information, and do they pay people to work for them and maintain it? Or do they hire someone else to do it for them?

Multiple firms are already in use of the same price from the same provider of in-running football, for example. How good would your odds need to be to beat the average punter if you only used in-house compiling? Can great management of risk hide a multitude of sins just by letting the best of the punters move the prices so that they have the best outcome for you?

It is sad to say, but only a small number of bookies allow that style of management of risk, or for the investment in greater pricing. Compilers are now understanding that a pound spent on advertisement and marketing can initiate a greater profit than the pound they could have invested in improving the quality of the software or on staff.

In general, any bookmaker has a goal of beating the 98% of all punters with the lowest number of staff possible. If we go into greater detail, bookies are most cost efficient when hiring young and inexperienced staff, in addition to give optimisation of software little or no thought. This is seen as a better option than hiring experienced odds compilers.

How Bookmakers` Business Models and Views on In-House Odds Compiling Has Changed

You might be convinced that since odds are the product served by bookies, they would be better off with focusing on developing their product. However, in the world we live in today, that is not correct.

For example, you wouldn’t base the choice of your hotel based on the cost of a beer in the bar compared to other hotels. Bookies look at odds at about the same level of importance as the price of that beer. The real product they are selling is entertainment, and not the intellectual contest between the bookie and the punter. It would be foolish to think that they have ever sold the product of this sort of competition. The product bookmakers sell is a rush of adrenaline, and those who still believe that characters competing with punters, and playing against each other in betting rings concerned with horse racing is what betting used to be, are greatly mistaken.

All punters have a different story and feeling towards how sports betting and bookies used to be. People I have spoken with remember the taxes in the UK, large margins, only a choice between a few bookies, refusal of payment when trying to withdraw money, and in some cases threats of violence when trying to get paid. I do not know where the image of a gentleman-bookmaker comes from. Over the years, bookmakers have taken bets and they have refused bets, they have allowed high stakes and they have refused them, and some have filed for bankruptcy and some haven’t. This has been the truth for square and sharp punters.

Every bookie expects to win in almost all cases, no matter what the quality of their odds are, and to improve channeling of their efforts in getting punters in the door, rather than having a cheap price in the bar when buying beer. I do not care much for this model, but I believe it is going to stick.

There Can Only Be One Pinnacle

Now, let’s dive into the compulsory paragraph about Pinnacle. Why doesn’t every bookie operate such as Pinnacle?

Well, the simple answer to this question is that there can only be one company at a time with the business model that Pinnacle possesses. Some might use parts of it in some areas of their business, but the model that Pinnacle uses isn’t easily duplicated.

Pinnacle’s tagline is that they openly welcome winners, and has stated that this is due to their wish to beat all square book with the best proprietary trading models that the market can offer.

Having the greatest employees (including odds compilers), betting on tiny margins, welcoming arbitrage- and sharp traders, in addition to changing the odds according to how sharp they are, the odds at Pinnacle will be the best representation of the probability of any outcome at sporting events.

Start with your limits low, and increase them according to the increase in your price. Not a penny will be spent on marketing, but everyone’s allowed to use the affiliate banners, in addition to giving your API to everyone you can. This includes arbitrage and services that compare odds. The low margins result in you being at the other side of arbitrage trades. The square bookie your price is up against is so bad at placing the price that you must be getting the value side of the arbitrage bet.

Actually, you will be getting this scenario again and again, but will always end up moving your price to make sure that you get every bit of value, every single time. This ends up with you becoming the greatest punter that William Hill, Ladbrokes, Bet365 and every other bookie has seen, without the need of opening even just one account. The risk management group that are in your possession are almost fully automated, and you need the services of an investment bank. To be able to set up and use this kind of model, they must be doing so with smaller margins than you, in addition to having a greater risk management and a lot of capital. The only example of someone giving this a shot at the moment, is Marathon, and they are still nowhere near the point where they can afford to keep winning accounts in their books.

But what about the Asian bookies that keep accepting winning punters?

Well, as long as they see a great amount of money coming in, they are happily accepting them to play. This is the case in football, certain American sports, and in the more known tennis match-ups.  

The Asian Handicap Model was designed to function at a low margin, move quickly, have a great volume of trades, in addition to not working with the sharp money. In some cases, it was designed to play at early and low limits, just like Pinnacle, while the market still forms. This should result in the risk being low.

Still, they don’t directly run a Pinnacle Model, but they have large enough square volume to use some of the same features of it, and handle a loss comfortably. This is IF the books as a whole, result in a positive profit.  

The Future of Odds Compiling

In the end, I think that compiling of odds will strictly become an outsourced function for bookies. Companies that specialise in compiling odds, both pre-match and in-running, will arise. Already, multiple companies provide this option, in addition to there being companies that provide liquidity to betting exchanges. Homogenised pricing is also something that will occur more often.

The reasoning for why you see a lot of similar pricing in today’s market, is that the liquidity in certain sports betting markets is of such a high volume, that we can see something that reminds us of a market price, similar to the financial markets. It doesn’t make sense for bookmakers to have deviating prices from each other in football that can be categorised as top-level. Trust me when I say that substantial studies have been completed, and that they conclude with the fact that trading against the market in a liquid sport is a loss in the making as a bookie. When you are going to provide thousands of odds over a very high number of events, it is easier and better, to simply just follow the market. 

Though, this might not be the case for a punter.

An increasing amount of companies will look at a market and tell you that the combined price from a liquid Betfair, Bet365, SBO, IBC and Pinnacle easily can be put together, and function more than well enough. These operations are not going anywhere, and see a very high amount of trades, which helps maintain the prices at a correct level.

“Why do they put up arbitrage opportunities, even in the liquid markets?”

The answer is that we are in a period of time, where the industry as a whole is in transition and sees changes. Some are still trying to understand and accept that the price of the market should be set from the flow of money, rather than the opinion of a trader.

I predict that bookies will have a growing confidence towards these consolidated feeds. They will eliminate arbitrage opportunities, or at the very least, with sharp sources, they will be cheap in use. I also believe that bookmakers will outsource all of the risk management tasks. There will forever be exotic markets attached to the core liquid ones, and if the bookies have any sense they will increase the limits at the core ones and decrease the limits at the exotic. This should be at a level of a 100 pounds takeout, which is a great amount for punters that are in this for the entertainment of it.

When focusing on horse racing, I have a few predictions. It might go in the direction of Starting Price only. I actually think that pari-mutuel betting with very low margins could be the way forward, making it into a universal Betfair with Starting Price. This type of pool betting has not been prevented in Asia, not with punters or professional bettors.

The problem that we have with the UK is the high amount of bad racing. Who knows what would have happened if bookies had pooled tickets, and if Betfair and the Tote had shared the profits, maybe it could have resulted in something valuable for everyone. This could potentially put to bed some of the bad Starting Price rigging that is happening.  

Betting will become just as much about beating the market as a whole, and not picking off the sick and the weak prices from the books. This will lead to a requirement towards punters and tipsters to understand the weaknesses and the strengths of the markets they work in, just as much as the sports themselves.

As a final word, I would like to say that you shouldn’t concern yourself with how the prices and the odds are set and compiled, or whether bookies show the same prices, as the only thing you should concern yourself with is to beat them. There will always be flaws and edges to be found in every sport, even though they get harder to spot, and shrink in size.

Written by: Matthew Trenhaile

 Follow Matthew on twitter: @CrazedAlchemist

 Read his blog here.

How bookmakers track your every move & how to avoid it (from an industry insider)

The article you are about to read originates from www.daily25.com. We have been granted access to it and we have been allowed to the information with you here, by Steve at Daily25 Blog. The original article was written by a writer with close ties to the industry, that functions as a companion to the Daily25 Blog. The insider works at a large bookmaker in Australia, and wishes to remain anonymous because of the love for his job. This particular person is someone I converse with on a regular basis, and therefore I will not call him by name, but I will rather call him “Spinsider”. As we share a lot in common with employees at regular sportsbooks, we often find ourselves emailing with some of them. Many of them have come across our site, and been in touch with me. It is easy to understand that we have a lot to talk about and to discuss.

In my case, I have found that the employees themselves at the large sportsbooks are great guys. A part of me always feel a little guilty when I criticise sportsbooks, because I personally know people that work there. It is, however, not their fault, as it is the owners that have created a culture that can be characterised as similar to the one in ”Wolf of Wall Street”. As every employee of any company is there to create a profit for the owners, this sometimes leads nice people to do things that could be considered disreputable.

 The following article should give an inside-view to what measures bookmakers take to profile all customers and that excludes any profitable bettors. As this is one of our biggest issues, this is an important story to publish. Not only for us, but for you as well. I`ll pass the word to our Daily25 Spinsider and I will be back at the very end to give my own thoughts and opinions on the matter.

From Inside A Corporate Bookmaker

A while back, Steve reached out and wanted me to write an article for his increasingly popular blog, daily25.com. Finally, here it is. Normally I would not be writing an article like this, but in this particular situation I can relate to Steve trying to educate others. This will work towards a fairer world of betting, and I have understood from my previous conversations with Steve, that he is a genuine and great person.

Who knows in the future, I might enjoy writing so much that I will publish my own blog. Hopefully Steve will give me some feedback on whether that would be possible to do or not.

A little about me; I have worked in the industry and world of gambling for about four years now in Australia, and I am currently working for a large corporation. Previously and currently I have done quite a bit of sports betting, and punting, and therefore I can relate to the two sides of sports betting. I have read articles, in papers such as The Age, that have annoyed me due to the one-sided nature of their writing. I have complete understanding for the bookie – and I will be the first to admit that I would not have a job if punters did not lose and paid my wages, but I also understand the perspective of the bettor, if their account gets limited or even closed. On the other hand, if bookmakers are incapable of turning a profit, you would, as a punter, have less opportunities to bet and exploit offers and campaigns.

It’s a circle. And the circle is of the vicious kind.

Why Bookmakers Limit Winning Players

The main objective of this article is to take a closer look at how betting accounts and profiles gets noticed, and the process of them being taken all the way to restriction and closure. No bettor ever wants to try to place a stake, and get rejected. “Why will they not take my money?” The short answer to that question: Yes, bookmakers limit or ban any consistently winning player. The most important takeaway from this article is how bookmakers profile players, but firstly, let us understand why they do it.

A corporate bookmaker has an overall objective of creating a profit for itself. This is the point of emphasis from the owners and the shareholders. If you are not able to create and increase your profits, you will be shown the door. Employees at the bookmakers look for ways to satisfy their individual targets and expectations set for them, and the easiest way for them to reach profitability and to increase their margins is to remove any punters that look like they might cut into these margins. Corporate bookmakers are not easy to understand and are tough opponents to have. These corporations have a high number of employees, with different areas of expertise. All of them have a need to get paid, and the same goes for the owners and the shareholders. In my honest opinion, there is a culture of being unfair towards the customer on a constant basis, when there is no need for this. This means that bookmakers try to mislead and use the very people that pay their wages.

Personally it annoys me as a punter, because I know for a fact that they do it to me. The difference between me and other punters is that I understand how it works.

How Bookmakers Identify And Profile Winning Players

Now, let us get to the point of this article – how accounts are noticed. At the bookmakers where I have worked previously, we have had teams that work entirely with risk, and who monitor the activity of customers, trends in the market and specific players, etc.

Below I will go through a few techniques the bookmakers use to profile:

- IP Addresses are tracked for accounts and for bets. This means that even though you create a new account with the names of, for example, your family, it will not work. If you ever place a bet or use the same account that has the same IP Address, the account will be flagged in an instance, and will be under observation in the time going forward.

Another example is the MAC Address, as this is information that is captured, but to my knowledge it is not used in the filtering process. In addition to this, bookmakers will notice if you and “your mom” begin placing the same bets, as your profiles will match each other.

-  Unique Accounts are put in place to monitor every person on the site. This means that the bookmaker has the information necessary to positively identify you, for example through date of birth, address, and so on. In addition, they get the device ID from your computer or phone. Whenever a new account is created somewhere, it is run through a database of information, to check whether it matches information from existing accounts. These accounts will then be grouped and monitored. 

- Cookies are used to track your movement on their sites, whether you are logged in or not. In Australia, cookies are automatic, meaning that you don’t really have a say in them being placed in your browser or not. In Europe, however, there have been created laws to protect users from cookies. Every movement on the website is tracked, gathered and analysed, and there is no way around it. The information gathered here is used to put users in certain categories, and to offer different campaigns and bonuses to them. These might be offered to exploit your weaknesses, or they might be used to make sure that you will stay and use their site.

- Social Media – The two bookmakers I have worked with have had intricate systems that are concerned with CRM, Customer Relationship Management. These systems are constantly evolving. The teams that are assigned to working with risk and customer service are constantly monitoring bettors that are active in social media surrounding betting, bettors that have industry knowledge, employees from other bookies, in addition to tipping service subscriptions. This information is saved at the account. Reports are compiled daily, on all betting-activity of the user, and these reports are monitored closely. People with similar twitter-activity are pooled together, whether they are official or not. This is the reason for why some accounts are closed immediately after creation. Even before creation of the account, the person is flagged for any of the reasons in this article, and might not be able to gain access to the intended site. I have seen examples of accounts being pre-created and banned, even before getting signed up.

The easiest way to flag an account is when people post their betting-slips in social media, and are immediately removed from the bookmaker.

- Staking – When an account is opened, the staking level is the same at every account. Once you start consistently winning over a longer period of time, for example weeks or even months, your staking level will be reduced to cut the losses they have on your account. However, if you seem to be a winning player in most sports, but for example struggle with winning in racing, your possible stake-amount will increase, only in this area. This can be done through shifting levels of staking between different bets, sports or competitions.

This is why you sometimes notice that you can stake very high on cricket (because you constantly lose here), and have a reduced stake at racing (because you constantly win here). The bookmakers are clever in this sense, and figure; “Why ban you completely, when we can still turn a profit from you?” At the moment, most of this is manually performed, although the data to make the decision is automated.

- Trends Betting – This occurs when you and your friends bet the same types of games at the same time of day. This will definitely get noticed.

At one of the two bookmakers I have worked at, we had measures to collect data that would expose bettors that played the exact same bets, even across bookies, and ultimately looked for trends in the market. If a big group of people place the same bets at the same time, it is clear that they come from the same tipping service. Let me make one thing clear: Bookmakers subscribe to these services themselves, to make sure they are always in the loop of things.

-  Tipping – One of my favourites. If you and your friends have ever created a personal tipping competition, it is extremely likely that you have been grouped together. If one of the bettors in the “group” is great at recognising what bets to take in one sport, the group as a whole is more than likely to have a reduced stake, due to this person’s expertise and probability of giving away this information.

- Betting Back – Do not make the mistake of thinking that every bettor with a profit on the horizon will be removed, as the bookmaker’s eye yet another opportunity to make a profit. This happens by the bookmaker following their players’ bets, and placing the same ones at another bookie or exchange, and turn a potential loss into a potential win. I have heard somewhere, that bookmakers have systems to check players that utilise arbitrage betting on Betfair markets, but I have never seen or been made aware of this myself.

Why Believing You Are Better Than The Bookmaker Is A Bad Idea

Since the Australian market has been in constant growth over the past five years, bookmakers have become highly advanced. Every participant in the market wants a piece of the pie. Don’t be blinded by the offers and campaigns they swing your way, as these are all for show and work in their favour. When Tom Waterhouse challenges you to play the same as him with enhanced odds, do not take it, because of the high probability of losing. This is something he is very aware of.

Bookmakers have models that will give them an indication of who the winner of a race or matchup will be. Someone who does this for fun stands no chance against the fifty traders that do this for a living in companionship with highly developed models. You will never win.

A bookmaker will only survive if it manages to take your money. They are not anything like a charity, they are a business.

How Bookmakers Will Identify Winning Players In The Future

The techniques listed above are the most common ones, but there are plenty more. I am certain that personalisation software will have the capability of pointing out every customers touchpoint or interaction that one has at any given time, so that they can predict our next moves. Do you want to stay clear of the attention of the Bookies? – Well, Big Brother is always watching you.

- Do not make more than one account at each bookie, clear your cookies, do not involve social media in your betting, and throw the bookie off a little bit every now and then by placing a bad bet. Everything is automatically reported and monitored.

I could talk all day about an abundance of topics, but I’ll leave it there. Hope to speak to you again in the future.

End Comments By Steve From The Daily25

The first thing I want to do is to give a great thanks to your industry insider, Spinsider. While the list is not fully complete, it will serve a purpose, as you have learned the rules of the game and you can take certain measures towards improving your abilities of setting up accounts and keeping them for a long time. I am in the fortunate situation where I have been working with IT in the punting area for fifteen years, ten of them with casinos and five of them with sports betting. The harsh truth is that creating clean accounts is a difficult process, but definitely a necessity in today’s world. If you are dedicated to place the correct bets every time, you will have to stay under the radar of the bookmakers, for good.

Techniques such as following your IP Address and MAC Address is easy to trick and work around. You also have the option of turning off cookies in the browser, and this can be easily avoided by using the incognito-option in the browser. Social Media, however, is a difficult part to stay away from, as from something as unremarkable as a “like” or a “follow” will lead the bookmakers to a large amount of information about you and your friends. The accounts where I have succeeded in staying away from the spotlight have all had non-present Social Media activity.

I am hoping that this article made you a little bit more aware of how much time and resources the bookmakers put into making sure that winners are kept out of their service, and that their winnings are limited as much as possible. Every bookie spends millions every year on staffing and the latest technology, to make sure their customers are only the losing ones. So much for the Australian ethos of a fair go. As most bookies are British, they do not understand that this will not be able to survive over a longer period of time. At least not in Australia.

Written by a guest contributor at www.daily25.com. Reposted here with the permission of Steve from the Daily25 Blog.

Exploiting arbitrage opportunities: From trading stocks to sports.

"Arbitrage is the simultaneous purchase and sale of an asset to profit from a difference in the price. It is a trade that profits by exploiting the price differences of identical or similar financial instruments on different markets or in different forms. Arbitrage exists as a result of market inefficiencies"

- Investopedia

How high-frequency trading firms exploit arbitrage opportunities in the stock market

With today’s technology, the pricing of stocks is updated within a few milliseconds of real-time. This is way faster than a human is able to perform calculations, which makes it difficult to find arbitrage opportunities in financial markets. As a result, firms who are performing day trading are now using computers to perform algorithmic electronic trading at a speed that is impossible for humans to match. The way this works is that you give the computer a set of instructions, which will trigger it to buy or sell stocks. These instructions can be related to price, timing, volume or a mathematical model. For instance, you write an algorithm that tells the computer to buy 1000 Tesla stocks whenever the price goes above $200 and sell if the stock price increases by 10% above the purchase price.  For more reading on arbitrage and algorithmic trading, check out the links. 

The non-fiction book “Flash Boys” by Michael Lewis, tells the story of how high-frequency trading (HFT) firms used a super fast fiber optic cable that connected the financial markets of New York with Chicago to perform arbitrage trading. This $300m cable reduced the journey time for data from 17 to 13 milliseconds. An advantage, which enabled the HFT firms to obtain better prices on their trades compared to their competitors.

To illustrate how this works in practice let’s imagine that a hedge fund wants to buy a 100 000 shares of Tesla stock. This purchase will be spread out on multiple stock exchanges to ensure that they get the best possible price on their purchase. As a result 60 000 shares are purchased on Nasdaq for $200 per share, but once someone buys stocks in a company, the price will increase. Thus there are only a limited amount of shares are available for $200. Once the purchase has been made the stock price of Tesla increases to $202 on Nasdaq. Therefore the hedge fund will look at buying the remaining 40 000 shares at a better price on a different stock exchange. At the London Stock Exchange (LSE) Tesla is still trading at $201 because the price has not been updated yet. What happens is that the HFT firm will notice that someone has purchased a large amount of Tesla shares on Nasdaq and therefore they will leverage their faster cable connection to purchase Tesla shares at the London Stock Exchange before the price increases to $202. So let’s say the HFT firm manages to buy Tesla shares at $201 per share at LSE. They then sell the stocks to the hedge fund for $201.99 and pocket a 99 cent profit per share. All of these events take place within a couple of milliseconds and are enabled by the firms using complex computer algorithms to perform their trading. In reality, the pricing difference is more likely down to 1 cent or less, rather than the 99 cents used in this example. However, if the HFT firm is able to perform thousands of trades like this during a day, then the profits will add up to huge sums in the end. According to the article at Harvard Politics, the HFT market produced profits of $5 billion in 2009, but declined to 1.25 billion in 2014. Also, HFT trading accounted for 73% of the total daily market volume on U.S. exchanges in 2014. A possible explanation for this decline can be found in the macroeconomics principle of perfect competition, which states that the existence of economic profits within an industry will attract new firms to the industry. The increased competition will result in diminishing returns for the firms and in the long run the industry will reach the state of perfect competition, an equilibrium where the industry profits equal zero. A second possible explanation is that the stock exchanges have improved their own connections, which reduced the relative edge that the faster connection provided the HFT firms.

According to Investopedia’s definition, arbitrage opportunities exist as a result of market inefficiencies, which allow investors to exploit price differences. Therefore it is not limited to just investments in stocks, but really any market where such opportunities exist. As a result the HFT firms also trade other types of securities such as bonds, futures and foreign exchange contracts. The rest of this article will focus on price inefficiencies within sports markets.

Arbitrage opportunities in sports markets

Within the world of sports betting there exists bookmakers where you bet against the house and betting exchanges where you bet against other people. The latter can be compared to a regular stock exchange, the main difference being that the traders buy and sell bets on the outcome of events such as a football game rather than stocks. What makes the sports market interesting from a trading perspective is that it is more inefficient than the financial markets, which in turn creates arbitrage opportunities. At the free site oddsportal.com, one can compare the odds of a game provided by different bookmakers and betting exchanges, which enables you to see the inefficiencies that exist within the sports market with your own eyes. I’ve included a screenshot of the odds from different bookmakers on the Liverpool – Manchester United game that was played on 17.10.2016.

Odds comparison

Odds comparison

The odds of a game’s outcome reflect what the bookmaker believes to be the probability of that outcome. The probability of an outcome equals the inverse of the odds, in addition one has to adjust for the bookmaker's payout rate, which is the amount of money that they pay back to their customers. For instance Mybet has a 90% payout rate, which means that they take a 10% cut of the money that is placed on this game. Next let’s compare the odds provided by two different bookies.

Sharp vs Soft Bookie Odds and Probability

Sharp vs Soft Bookie Odds and Probability

What we can see here is that the two bookies differ greatly in what they believe will be the outcome of the game. Now this leaves us with the question of which bookmaker is right and are either of them able to accurately predict the game’s outcome? The earlier screenshot above shows that Mybet’s odds for a home win is 2.40, while the closest bookmaker is at 2.27. This large deviation from the rest of the market indicates that Mybet is the bookmaker who underestimates the probability of a Liverpool win. The consequence of Mybet having mispriced the probability of a Liverpool win, by placing their odds at a higher level than the rest of the market, is that it creates an arbitrage opportunity. More specifically it makes it possible to put money on the outcome of a draw and an away win at two other bookmakers with a guaranteed ROI of 2.62% as can be seen in the screenshot below.

Arbitrage Bet / Surebet

Arbitrage Bet / Surebet

This is what is referred to as a surebet. The advantage of surebets is that in theory you are guaranteed a profit without any risk. Surebets are also called arbitrage bets and have been covered in even more detail in this article. While this article covers some practical experiences of using arbitrage betting from Vida, a guest contributor at the Trademate blog

However, the majority of surebets will occur at the soft bookmakers (will be defined later), which can lead to several practical disadvantages:

  1. Soft bookmakers limit sports traders who are able to win consistently.

  2. You need to find high enough odds on all of the outcomes for it to add up to a surebet.

  3. If the odds deviate too much from the rest of the market, bookmakers are able to void bets placed on that game. Imagine the following scenario: you are following the recommendation in the screenshot above, by placing money on a home win at Mybet, a draw at Vulkan bet, but when you are trying to place a money on an away win at Leonbet, you are limited to place a maximum of $1. You are now unable to complete the surebet, which results in a huge negative expected value on the bet. (If you are unfamiliar with the statistical concept of expected value (EV), read this short article) Now whether you are investing in stocks or sports the most important principle is to avoid loosing money, because if you loose 50% of your capital ($10 000 → $5000), you will need to increase it by 100%, just to return to the starting point ($5000 → $10 000).

  4. You will need to distribute your capital and thus tie up your capital across a very wide range of bookmakers to take advantage of the surebet opportunities.

Difference in estimated probability between soft and sharp bookmaker

Difference in estimated probability between soft and sharp bookmaker

Because of the disadvantages with arbitrage trades (surebets) listed above, a better strategy is to place a high volume of +EV trades. An example of a value trade would be to place money on a home win to Liverpool, which has a +6.06% EV. Over a large sample size placing +EV trades should be a profitable strategy in theory. This is based on the assumption that the Asian Bookmaker's odds accurately reflect the true probability of a game’s outcome, which is covered in this article. 

 

WHY INVESTING IN SPORTS OVER STOCKS MAKES SENSE FOR PRIVATE INVESTORS


A rational investor will attempt to maximize returns while minimizing risks. This implies that they will invest in the markets or financial instruments where the potential return / risk ratio is the highest. Investors in financial markets can broadly be divided into two categories: Long-term oriented investors who rely on fundamental analysis and short-term oriented investors who follow a trend or technical analysis. The former are often referred to as value investors, which means that they try to identify assets that are underpriced by the market. They also require the asset to be significantly underpriced, which provides a margin of safety, before they purchase a given asset. What I view as the main disadvantage for the value investors is that, because they are oriented towards the long-term, which can be anytime between 3-10+ years, it means that they will tie up their capital in investments for a long time before potentially reaching a positive return on investment. In the meantime, you do not know whether your hypothesis that the asset is underpriced holds true.

The opposite of strategy would be day trading, taking advantage of short-term price discrepancies in the market. Day traders apply different methods such as looking at chart patterns or technical indicators in order to predict future market movements. Now the main disadvantage with being a day-trader is that computers are superior to humans in performing statistical analysis and for discovering patterns in large datasets. Thus gaining an edge in the market when you are competing against HFT firms is very difficult. The gap in access to information held by hedge funds compared private investors have increased dramatically in the last decades. Today hedge funds can rely on real-time satellite images of the parking lots of JC Penney to predict their quarterly returns, while private investors rely on historical financial statements. The result being that it is very difficult for private investors to compete against the professional hedge funds, especially if they rely on technical analysis. This is because, if there does exist price inefficiencies in the stock market it will be exploited by the HFT firms way faster than any private investor is capable of, returning the market to an efficient state. Thus in practice, the day trader performing technical analysis is competing against HFT firms, with access to less information and using inferior methods.

To manage risk the principle of portfolio diversification is followed by both groups of investors. The short-term investor will typically mitigate risk, by making a high volume of smaller trades with low risk and low returns that add up and provide a positive ROI. In comparison, value investors will make a lower volume of investments, but with a higher potential ROI on each of them. Similar to the day trader a sports trader will perform a high volume of smaller investments on the sports market. With any strategy, it is important to set up a feedback loop that provides you with data on how your strategy is performing. Within sports trading, the natural benchmark is to measure whether the odds you are putting money on is able to consistently beat the closing lines of the sharp bookmakers. If so, you will have a positive expected value, which in theory should lead to profits over a large sample size of sports trades.

Poker players will be familiar with the difference between the short and the long term. In the short term is possible for anyone to win, regardless of skill. Because luck or randomness has a large impact on the outcome. While in the long run, the random variance will even out and the players who have an edge will be the ones making a profit. The same holds true for people who trade in both the stock and the sports markets. Anyone can make a profit in the short term, but in the long term only traders who make decisions with a positive expected value will be profitable.

How price differences occur in the sports market

The reason that computers running algorithms are used to trade in the financial markets is because in these markets prices are updated so fast that it almost impossible for humans to exploit. In the stock market the difference in price that you will be able to obtain when purchasing Tesla stock at Nasdaq versus LSE is close to identical since the updates happen within milliseconds across exchanges in different markets. While in the sports markets the same asset, the outcome in the game between Liverpool and Manchester United is priced differently at different bookmakers or exchanges. In addition, these inefficiencies are not necessarily corrected in real-time. For instance, in the game between Chelsea vs Manchester City on February 21st, 2016 it took the bookmaker Norsk Tipping almost 30 minutes to adjust their odds compared to the Asian market, as seen in the image below. You can read more about how value occurs in the sports market by clicking the link in the previous sentence. 

How value occurs in sports betting markets

How value occurs in sports betting markets

Now compare this to the stock market, where the price would have been adjusted within milliseconds. These market inefficiencies create arbitrage opportunities that can be exploited by smart sports traders.

Being a sports trader

For professional sports traders, the majority of work is put in during the weekends because this is when the majority of games are played. In a given weekend you can potentially run through your bankroll multiple times by placing a high volume of sports trades. Trades are typically placed within a couple of hours before the game starts to reduce the variance that may occur between the opening to closing lines of the bookmakers. Thus the capital of the investor is tied up in the investment for a shorter period of time. The result being that you can grow your fund much faster, than for long-term investments in the stock market.

For example, if your bankroll consists of $10 000 and you place sports trades with an average of + 3% EV per trade. +EV being the trades where you get a higher odds than the closing lines of the sharpest bookmakers. Now let’s assume that you place your trades with a flat structure* of $100 per bet and that over the weekend you place 100 bets. Then your expected profit would be: 100 (trades) x $100 * 1,03 (EV)  - $10 000 = $300. Now obviously, whether you endure winning or losing streaks will have an impact on your actual profits . If we assume that there is no variance in the 100 trades we placed or in other words that we are neither lucky nor unlucky, our actual profits would be equal to our expected profits of $300. In reality, the variance will only even out if you are able to place a high amount of +EV trades

*Your bet sizing is an important topic when trading in the sports market. You can read more about bet sizing in this article

Conclusion

To sum it up there are 3 main advantages of trading in the sports market compared to the stock market:

  1. Market inefficiencies enable arbitrage opportunities.

  2. Shorter investment cycles provide a higher potential for profit growth and reduced capital tied up in investments.

  3. Faster feedback loop on strategy performance.

Written by: Marius Meling Norheim

Disclosure: Neither I, nor Tradematesports have any affiliation or receive any form of compensation what so ever from any of the bookmakers, websites or companies mentioned in this article.