Sunday, September 2, 2007

The "Sure" Thing

The year was roughly 1984. There was a horse racetrack not all that far from me. Well, I knew how to program a computer so I figured one summer that I'd just see what I could extract from the racing forms. At that time, there weren't that many people who knew how to even operate a computer so I clearly had an advantage, or so I thought.

I knew I wouldn't be able to compete with others in spotting the best horse but maybe, just maybe, I could mine the data for some sort of pattern in the betting. It is one of the few forms of gambling where a betting system could theoretically work. I'd just have to bet much "smarter" than the average person competing against me (in order to offset the money from the pool the track takes). I therefore put a year's worth of race data into my computer and to the best of my memory (it's been 20+ years) this is what I found.

In a six horse race, the 4th best horse to win (according to the betting consensus) was paying more than the $2 bet on average.

In a seven horse race, the 4th, 5th, and 6th best horses to win paid more than $2 on average.

In an eight horse race, the 5th horse to win paid more than $2 on average.

In a nine horse race, the 5th, 6th, and 7th best horses to win paid more than $2 on average.

In a ten horse race, the 6th, 7th, 8th, and 9th best horses to win paid more than $2 on average.

I looked at that data and thought I'd just found gold. I started to think about how that could be? I decided that perhaps the city was just too conservative. Nobody was taking enough risk. (Sound familiar? It should. Think subprime!)

But that's not all. I saw more patterns. The system worked best on the weekends. That made perfect sense to me. The most experienced gamblers played throughout the week but the most inexperienced bet on the weekends. That seemed clear. This backed my original theory and improved my confidence in it.

I'm not done yet though. There were patterns in the exactas and the trifectas. They paid especially well and the system was once again very consistent. The best bet was pairing the favorite with the 9th best horse in a 10 horse race for the exacta. For the trifecta, I should bet the favorite to win, the second best to come in second, and the 9th best horse to come in third. The system was simple, elegant, and believable. It was all coming together very nicely. I had a system and a theory that explained the system. What more could I want?

So off to the racetrack I went. I'd bet $2 on every horse in my system. I'd wait until the last possible second and let the consensus determine my bets. I'd often find myself rooting for four horses to win in the same race! One time I remember yelling, "Anything less than 5!" That turned a few heads, lol. People thought I was nuts, but I walked away with money virtually every single time I went out there. Even on bad days, I'd only lose a little, simply because I was making so many bets that the averages worked in my favor. It paid for my admission thoughout the summer and I built up quite a little sum in reserve. Things were going fantastic. Oh the stories I have. I predicted that Father's Day weekend and Memorial Day Weekend would be especially good (because people were allowed in for free and the place was packed). Yep, those were the two best days of the year. I won an exacta and FOUR of the races (betting on longshots no less) on one of those days and did extremely well on the other. This system can't lose!

Near the end of the season I'd accumulated enough money to increase my bets. Well, sign me up. We're talking gift horses here and I was fully prepared to look them in the mouth!

That timing didn't work out so well though. Much to my surprise, the day was a disaster. None of my horses won in any race. The system completely and utterly fell apart. The next weekend I opted to pass. I wanted to know more about what went wrong. That was a good plan. My system would have once again done poorly. This was quite a shocker to me as you can imagine. I'd pretty much proven the "sure" thing all summer, but something had changed. I had no idea what it was.

That's when I opened the newspaper. Any guesses on what it said?

JOCKEY SCANDAL! It seems a stableboy had ten winning trifecta tickets. Each ticket paid just over $600 which meant, at the time, it had to be reported to the IRS. Well, somebody started wondering why a stableboy would have ten winning trifecta tickets in the first place apparently. From there, it all went downhill. At least one jockey was banned for life.

Oops! I wasn't winning because the city was too conservative. I was winning because the races were rigged! Guess which horses tend to win in rigged races? You guessed it, longshots! My longshots, lol. From then on out my system never worked again, nor did any other system I managed to think up. Some came close, but there was just no way to offset the rather sizeable amount the track took from each pot.

Yes sir, I might just as well have been running the show at Long Term Capital Management. Everything was fantastic until MY system seized up on me. Genius failed, lol. Fortunately, I did something far different than the people at LTCM though. At the first sign of danger, I shut my system down. Whew! I never was a gambler by nature. In order to play, I had to know the odds were in my favor. That first day of exceptional losses shattered my confidence. Overall, the season was still enjoyable. I'd only lost all my previous profits. I basically gambled for free that summer. I didn't lose overall but I didn't win either.

Maybe you'll think of my very humbling story the next time you are looking at a chart. I know charts. They'll lure you in and spit you out if you aren't careful. Even your gut can betray you, but mine has perhaps seen enough by now. With the fraud where I worked, the fraud in some of my investments, and the fraud at the racetrack my gut is quite the natural skeptic these days.

There is no "sure" thing. There is risk vs. reward. It isn't the known risks that will get you more than likely though, because you'll see them coming. It is the unknown ones.

So what's my gut think the worst risk of all is? Never bet on the "sure" thing!

Markets are constantly in a state of uncertainty and flux and money is made by discounting the obvious and betting on the unexpected. - George Soros

4 comments:

MAB said...

Stag,

To me, this was your best post. Entertaining and instructive on many levels!

Precise calculations on imprecise assumptions. A concept that has always stuck with me. In this vein, the OER changes to CPI really bug me. Especially in the context of a housing boom and bust. I've roughed out some of your charts (by hand) based on a higher CPI from 1983 through today. Goes along way to explaining the explosive growth in the inflation adjusted Dow and MZM charts. Both become less parabolic.

Real estate and debt remain ugly. If we have a debt crisis, we have a banking crisis.

Overall, I think your conclusion is valid - real yields are on life support and will be well into the future. Making money from money (as was done over the last 25 years) seems VERY unlikely from here.

This is a tough pill to swallow. I have some MONSTER college bills to meet in the future. I have to believe that many boomers and big spenders are in for a big shock.

Stagflationary Mark said...

MAB,

Making money from money (as was done over the last 25 years) seems VERY unlikely from here.

If memory serves, destroying money from money happens all the time when playing Monty Hall.

Which door do you want?

1. Earn Negative Real Interest Rates?
2. Buy Overpriced Assets?
3. Win Dream Vacation Getaway to Candy Mountain (tax rebate)?

Who wouldn't pick door #3? It is a "sure" thing by comparison! I probably should mention that it includes "free" healthcare too! We'll just borrow it all and let future generations figure out how to pay for it.

Candy Mountain
http://illusionofprosperity.blogspot.com/2007/11/happy-thanksgiving.html

Oh when you're down and looking for some cheering up then just head right on up to the Candy Mountain cave. When you get inside you'll find yourself a cheery land such a happy and joy filled and perky merry land. They've got lollipops and gummidrops and candy things...

If the "something for nothing" dream could be a reality we'd be doing it ALL the time. So why don't we? Why are we especially prone to embrace the dream when times turn a bit tough? Desperation?

MAB said...

Stag,

Why are we especially prone to embrace the dream when times turn a bit tough? Desperation?

That's an interesting question and observation. For some, such as those that planned their future purchases based on 12% annual returns, it could be desperation. I don't think I'm desperate, but I must admit that I still don't want to let go. The powerful lure of easy money or a free lunch I suppose. Perhaps its just hard to unmoor "well anchored" expectations. A body at rest.

Apparently, I need another hour or two on that demotivator web site!

One more related thought. In the 1970s, pension funds based their actuarial projections on a 6% rate of return despite much higher prevailing current interest rates. Their actual returns exceeded expectations. In the 1990s, the projections were ratcheted up to 10%, despite much lower prevailing interest rates. Seems like we are now planning for the best as opposed to preparing for the worst.

We live in the extremes.

Stagflationary Mark said...

MAB,

Speaking of pensions, check this out!

Signs Of The Time, Part 3
http://www.boom2bust.com/2008/02/11/signs-of-the-time-part-3/

Many people expect to get pensions but, curiously, don’t have them.

I'm beating my forehead against my desk. I hope you realize that, lol.