Football games and efficient markets
I am not a football fan. But I did kick a ball around in the street with the other kids, as a young boy growing up in London. I never imagined I’d become a prop trader then, for a big bank, and then independently, or at some point pontificate on the parallels between football and the markets. Actually, when I was 6 I thought I was going to own a factory when I grew up. In fact, there are few aspects of my life that I predicted, guessed, or even hoped for. I am told this years World Cup has been an especially unpredicted one, full of surprises and unexpected outcomes.
Goldman Sachs, known more for trading and statistical models for the financial markets, has also built sophisticated models for predicting the outcome of sporting events, including football. Their football model analyses decades of football data. This year, they predicted Brazil would win, having faced Netherlands in the final. They were as wrong as they were last year about US Treasury bonds…but that didn’t dent their confidence and nor will this.
Well, as we know, Brazil suffered humiliating losses, as much black swans of football as the global financial crisis was a black swan on the stage of world finance. The final between Argentina and Germany was close, two giants of the game balanced in equilibrium, nil nil, until the ball was flicked into the penalty box, received onto the chest of Germany’s 22 years old, Götze, who then volleyed it past the Argentinian goalee and into the back of the net to win the World Cup one nil. And Lionel Messi, that handsome football genius, was supposed to score a minimum of one goal, according to perceived wisdom. How is it that us humans just can’t resist making predictions of the usually unpredictable? And why are predictions of adaptive systems like the markets, or football games, most hard to get right?
When games of football are gambled on the language is the odds. Punters place bets, their risk to reward ratio determined by the odds the bookmaker has offered. In circular fashion, the odds the bookmaker offers reflect the past bets made by punters, as well perhaps as nuances of the bookies algorithm. And if any certain opportunity to profit exist it will be quickly adjusted away by an infinite numbers of punters, from the ones smoking outside a seedy William Hill betting office on Streatham High Street to the vast numbers online. And if all known information is then reflected in the odds then the punters will scratch their heads and say, hey, it’s hard to see how I can make money. It’s hard because the odds ensure certainty is ironed out, leaving just uncertainty to play with.
And if the powers that be usually try to pair up roughly equally capable teams anyway, Liverpool versus Manchester, say, rather than Liverpool versus “Bus Drivers Weekend Wanderers”, say, then even before the magic of an efficient football odds market has had it’s chance, those balanced pairings will ensure there wasn’t much certainty to begin with. More profoundly, football has been globalised. Talent travels, players are often international. New strategies are quickly learned by competing teams. Tic tac toe is a zero sum game, once all players know it’s rules we can only predict ties or near ties, no matter what the latest version of the game. And as the punters grow in number and the internet ensures an instant and equal spread of information, the game of betting on football just gets harder. Same forces act on the markets…information is readily available and the system is adaptive.
So like the markets, football is harder and harder to predict and it is harder and harder to beat the odds. Am I saying money can’t be made? Of course not, I’m a trader. But I am saying the feeling of uncertainty never goes away, it can’t be escaped from. Now, footballers play no differently as the odds change, but the odds are swayed by the weight of punters bets. We can argue real events in the markets go a step further. Suppose the Fed is thinking of hiking early and word gets out through one comment or another. The bond market sells off, the implied odds of a hike rise. The Fed sees this and thinks, well, higher yields are doing the job of tightening for us…so we don’t need to hike now after all. So the Fed acts on the odds and the odds act back on the Fed. But in both football and the markets the odds adapt to our forecast…and that adaption isn’t cooperative on the whole which means it must on the whole be malevolent.
Both teams in that World Cup final were of course full of the most fantastically talented players. I am in awe of the speed, the dexterity, the agility, the bravery, daring, determination, the raw power, the acuracy. It is precisely because they were both great teams that the game could hang in the balance, brilliant attack blocked by brilliant defence, until some tiny, almost random, change of direction allows the outcome to spontaneously morph into decisive non equilibrium. If either one of these players had been up against a more ordinary collection of players then the game would have been predictable, with high certainty.
Uncertainty is a reflection of balance, perversely. Certainty reflects Imbalance, also perverse. Balance is achieved when opposing forces are equal, all known information factored in. When all we know is known by all others then what we know becomes worthless. If everyone knows what everyone else knows then that information becomes priced, reflected, and of zero value. That’s why some traders run the risk of going to jail by insider trading…they get what the deserve by the way. Market outcomes are determined by what we find hard to know and so we are once again plunged into uncertainty. It is balance that creates uncertainty. And if all current external information is of zero value, then we can only profit from either internally generated information, such as technicals, or from our ability to forecast future external information, events that will transpire and surprise the market.
In most circumstances the markets are in a fine balance…but usually with a very short lifetime. Balance is like radioactivity, it always has a half life. Information is absorbed, traders adjust their positions relative to one another. Some open new positions, some take profits or losses. Once new information has been absorbed, the market shifts into a new, again short term equilibrium. Absorbed information again becomes worthless. That flurry of activity reflects positions opened and closed, liquidity and the ability of the market to clear.
New equilibrium are never really stable, but once a new item of news has entered the collective conscience of the market, it usually stays fairly quiet for little while. The market can be in equilibrium in many ways, rarely stable ones.
It can be like a tug of war between two equally strong teams. Or it can be like two sumo wrestlers pushing against each other, locked into stillness for a moment. Or it can be equilibrium of any other type. The market can start to move again, it might move slowly, or it might lurch from one side or the other, melt slowly higher or crash. Balance quickly opens the door to chaos. Whether subsequent moves are the result of new information isn’t even the right question, information can be internal or external.
Momentum buyers can respond to momentum, so momentum itself becomes a form of information…just as much a signal as a nod and a wink frm the Fed…but not external information. Quite often what may well be spontaneous, self created momentum leads traders to invent “news” where in fact there is no external explanation. If the bond market sells off a little, the selling causes more selling and soon enough the commentators out ther are saying the Fed is getting more hawkish….they invent an explanation. Or a rising stocks results in stories of imminent M&A activity….it’s random momentum resulting in fictitious news.
So the concept of balance and efficiency isn’t what people assume it to mean. Efficient markets aren’t what people assume them to be . They are efficient, but not stable, predictable, transparent, cooperative or proportionate. From balance to crash, like nil nil to victory or defeat, on a random jiggle of the ball, direction can change on a single dime.
So is there a conclusion? Well, I suppose it’s this. First, don’t get sucked into group think…avoid relying on market cliches and platitudes like never going against central banks, buy in May and go away, buy the rumor sell the fact..the only good cliche is buy low and sell high…don’t think perceived wisdom is reliable information….and dont think the market isn’t efficient, it’s just that it’s efficiency is not of the kind that you thought. In my own trading I have to remind myself of all this now and again, and the World Cup served to remind me once again. Finally, accept and embrace uncertainty. There is no point in waiting for more certain times. They will never come. They just can’t.