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| Does this man know losers? (jonathantimmes.com) |
Thursday's show included a segment (2:45 to 18:05 of the 3rd hour) in which Czaban described his new system for picking National Football League games against the spread: instead of figuring out what teams are "sure winners"—that is, likely to outperform gamblers' expectations as embodied by the spread—he's looking for "sure losers"—teams that are likely to underperform gamblers' expectations. (Then, of course, he would bet against his sure losers.) Since adopting this method, Czaban claims his losers are 5-18-1 against the spread, meaning that if he placed bets, he would have won 75% of the time.
Am I crazy for using this method, Czaban asked his fellow cast members. They assured him he was. After all, if you can identify losers, why can't you identify winners?
Yet in finance, plenty of people use the same method as Czaban—they try to pick "losers" that will underperform. Those traders aren't crazy—at least, they're no more crazy than people who try to pick "winners" that will overperform. If finance is a good guide (and I think it is), Czaban's method likewise is no less sensible than gamblers who try to identify winners.
There are many similarities between finance and handicapped sports gambling. In finance, the price of an asset is set via market equilibrium between buyers and sellers. The price is thought to equal the expected future returns on the asset, discounted for time (i.e., the investor gives up some of his money for a time, until the investment pays off) and risk (the investment may not pay off as hoped). In handicapped sports gambling, the spread acts sort of like an asset price, set via an equilibrium between gamblers betting on either side of a game. If a stock outperforms its price or a sports team outperforms its spread, then the investor who bought the stock and the gambler who bet on the overperforming team "win"; if the stock or team underperform, then the investor who sold the stock and the gambler who bet on the opposing team "win."
In finance, there are folks who pick assets they believe will underperform market expectations. These are "short-sellers"—they sell assets today that they don't own, but then (I'm simplifying here) they purchase the assets in the future in order to complete the deal. They do this because they think the price they'll get for an asset today is higher than the price they'll pay to purchase that asset in the future. Put differently, they think the asset is a "loser" that will underperform current expectations.
Why would a trader short? Remember that he's looking for assets that will underperform current expectations—that is, assets that are overvalued by typical investors who in turn are bidding up the asset's price. Shorters believe they are good at knowing when "the herd" is overvaluing.
Can this strategy be applied to sports betting? I think so; here's one way: Remember Lou Holtz's addage that a team is never as good as it looks when winning, nor as bad as it looks when losing—a sports version of recency bias. Suppose teams A and B are playing each other, and A had a big win last week—one that gets its fans giddy about their prospects against B. Those fans may then put their money where their school pride is, prompting bookies to adjust their spreads—and increasing the likelihood that A may underperform gamblers' expectations when A plays B.
After reading this, you might be eager to give Czaban's method a try. But something should give you pause: In finance, shorters as a group don't seem to outperform the broader market over the long run—at least, not when you factor in taxes and fees. And futures buyers (the equivalent of gamblers who try to "pick winners") as a group likewise don't seem to outperform the market. The reason for this is that markets that shift equilibrium in response to the investor equivalent of A's chesty fans, usually (though not always) then re-shift equilibrium when folks like short-sellers make their subsequent move. That's why it's difficult to consistently cash in on either a "sure loser" or "sure winner" strategy. There's a Wall Street adage that you seldom find a $20 bill on the ground—there are too many other people out there who would scoop up the easy money before you get to it. But every once in awhile, you do find some money on the ground. Likewise, you seldom find a gambling strategy like "sure winner" or "sure loser" that pays off consistently—but sometimes it does.
So how do you win at gambling or finance? In handicapped gambling, the best strategy is simply not to play—it's likely that even if you are good at identifying sure winners or losers, your winnings will be eaten up by the vigorish over the long run.
In finance, fortunately, the story is different. Unlike in sports where there must be at least one loser for every winner, in investing it's possible for there to be many more winners than losers. Moreover, the time discount implicit in asset prices is very large. The best popular-audience book ever written about finance, Burton Malkiel's Random Walk Down Wall Street, explains that being patient, following a buy-and-hold strategy, using index funds, diversifying assets, and using tax-advantaged investment plans will result in investors picking a lot of winners over the long term. As Malkiel says in the book's introduction, he can't tell readers how to get rich quick, but he can help readers build wealth slowly but surely.
Of course, it's more fun to pick individual stocks and bet on ball games—even Malkiel confesses that he indulges in some stock-picking. Just remember that such betting is likely to lose money over the long run, once fees and taxes are factored in. So treat it as entertainment. As one of Czaban's favorite sound bites says, bet with your head, not over it.
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