Market Capacity

In a previous article I mentioned capacity. This is something you must always consider when building a trading model. Does the market have the capacity that permits you to place bets of a large enough size to enable you to make your required profit?

Such a consideration of capacity is also used in financial markets. Currently, I am reading The Quants by Scott Patterson where capacity is given a mention with repsect to hedge funds.

Hedge funds are often closed to new investors because the fund would have no use for any additional capital. The markets being traded on by the fund are not able to take trades any larger than are already being made.

One enterprising hedge fund (Google - Centaur Galileo) was set up to trade only on sports but soon went under, after losing $2.5 million through bad luck. Assuming the fund was managed by competent people (and I have a feeling it wasn't) then the fund would have ramped up against market capacity and would have been unable to make a serious profit.

Financial hedge funds are commonly worth billions of dollars and trade in financial markets, which are valued in the hundreds of billions. There just isn't the capacity for a billion dollar fund on sports betting exchanges, where the total volume is measured in a few million per horse race. Not enough for a multi-billion hedge fund to get its teeth into.

If trading on Betfair a fund would also run into the 60% commission charge because, naturally, the fund would be turning over and presumably winning enough to incur the hefty commission Betfair charges the big players. And which fund can justify trading at such exorbitant transaction costs?

As soon as market capacity is reached, either the sports hedge fund would have to close itself to new investors or start taking unhedged risks, which would go against the ethos of the fund. There have been no further attempts at creating a sports hedge fund and I don't see a sane person trying to again.

Capacity is also something that should be understood by people who think that the Martingale System is going to bale them out of trouble. The market will never have the capacity to cover the eventual infinite bet that the Martingale fallacy requires. Even a sub-infinite bet will be declined if there isn't someone on the other side to cover your bet.