Understanding the Wager Pricing Policy of Bookmakers in the 2014 FIFA World Cup

I came across an interesting observation during this world cup, this time in relation to the pricing mechanism followed by the bookmakers.

This graphic shows the betting quotes on bet365.com of an outright WC win for each of the participating teams. Going by the law of demand, ceteris paribus, the bet price of an event is an inverse function of its probability. Hence, we can clearly see Brazil, Argentina and Germany are the obvious favorites of the bookies. Now an intelligent investor/gambler would be one who can compare the actual winning probability of a team vis-à-vis its speculative probability of winning. This is similar to arbitrage trading where the price difference is discovered between a security's fair value forward rate and its existing market value forward rate and thereupon arbitraging the price differential to earn profit. However in case of stock market, the inefficiencies decrease with time and the market price tends to move towards the actual fair value whereas in a betting exchange (which consists of more 'emotional gamblers' rather than 'wise investors'), the bookmaker would allow certain inefficiencies to exist so as to attract high volume of transactions.

In the current context, the actual winning probability of teams like Brazil and Argentina might be less than their speculative probabilities (as based on bet365 quotes) especially considering a likely Group 16 Brazil-Spain clash and Argentina's below par performance against Bosnia. On the other hand, teams like Italy and France who are coming at the back of decent performances are being traded at high prices i.e., the bookies want to make you feel that Italy is six times less likely to win the WC than Brazil. That's not right, is it?

Now before I end, I need to make an important disclaimer. Wagering agreements are illegal in India. I do not profess or encourage any sort of irresponsible gambling whatsoever. The above observation is just to share the application of basic statistics and investment fundamentals in sports. Enjoy the game!

Equity markets at All Time High - The investment dilemma starts here!

Hello everyone for the first article of my new blog series 'Investment Calculus' where I will try to share all the latest ideas and trends in the field of finance and investment and discuss many interesting business strategies of some of the biggest corporates in India and globally.

In this inaugural blog, I will take guard for the Indian equity markets which have been making new all-time highs recently. In the last one year, it has generated 28% returns (3 times of what your bank pays you for FD) and 21% alone coming in the last 3 months. Now in such a situation, investors usually have the following decisions to make - first, whether to hold the securities or to sell and book profits and second whether to enter the existing bull move and buy securities at fresh prices.

Individually for each of the dilemmas, I will take positions and suggest the following steps for maximising of your returns.

1. Your portfolio has given 20% returns since last year and you wish to hold the securities in anticipation of further gains.

This section of investors would include a majority group of people who bought securities at the time Sensex was hovering between 18000 and 20000 in 2013. The fact that they persisted with their portfolio amidst high volatility is an act that deserves them of the 20% gains they have received in one year. A zero-risk Fixed Deposit gives maximum 9% returns in an year, so anything that is double of it is simply awesome. Isn't it?!

Now then 20% gains - Okay! There would be a high temptation to book the profits now lest the markets fall and you lose what you've gained or even vice-versa. I would suggest at this point of time, it is important to study the time horizon of your investment. If you intended it for a long term at the time of buying, stay invested. However, you can also adopt to average costing i.e. by selling 50% of securities and let the remaining invested. This will inspire some confidence that you have at least generated some real cash returns. If the initial motive was to invest for a year, quietly book your share of short term gains and go shopping. In case your portfolio is nearing 12 months, you can wait for it to save the capital gains tax.

2. You have seen the markets making new highs and want to enter it afresh.

Well..well..well. This section has the maximum number of people. In fact the public interest in stock market has never been so high in this country as now. The turnover of trades on the stock exchanges has increased by more than 300% in last few weeks. Good business for the brokers.. ya!

Now again I move towards your stated goal of investment. If you are looking for any long term investment in an equity-linked mutual fund, the time is ripe. If you want to trade in securities directly, it is better to check the company fundamentals before you pick the stock. In case of active trading (i.e. trading for immediate gains), I recommend to wait for a reversal which can be expected at around 7600 Nifty level, then buy on the subsequent bear reversal which could be around 7100 level.

A strict warning

At this moment I also recommend NOT to follow the Technical Chart Analysis of mid-cap or small-cap stocks as the market optimism in the stock prices is derived out of the General Elections results rather than any improvement in economy. The P/E multiples of most of the companies are higher than their 10 year averages which implies that the stocks have been trading on high premium. Whether or not these stocks do well, avoid them if you want to play safe. Period.