The Paradox of Skill

Buchdahl's Squares & Sharps, Suckers & Sharks (pages 137 to 142) describes the paradox of skill, whereby increasing levels of skill within an environment results in luck playing a greater role amongst participants in that environment. This paradox can be applied to both sides of the trading coin; namely traders and the underlying assets they are trading on.

Leicester City's remarkable Premier League title win 2016 can probably be put down to a combination of Leicester City playing above their mean expected performance level and the usual suspects playing below their mean expected performance level. A season later and it appears that Leicester City have not only mean-reverted but gone through to the other side and are now playing below par. We will put Leicester's surprising performance to one side and deal with long-term trends. 

The usual chant from one soccer fan to another is, "You bought it!" Over the past few decades more and more top-flight English soccer clubs have been bought up by the super-rich, a trophy club to go with the trophy wife. Obviously, the wealthier the patron the more likely they are to buy a big name team. A wealthy patron brings a bigger budget and with that comes playing and coaching talent from across the globe.

Eventually, all the top clubs will be bought up by billionaires, leaving other billionaires with no option but to create their own Premier League champions through buying lesser teams, lower down the league and in the Championship. Huddersfield Town, for any of you billionaires out there? After all they do have a history of winning the old First Division title so they have pedigree.

When the Premier League has become the NBA of soccer, every team will be supported by a billionaire. With all teams paying for the best talent, the chances of another unexpected champion, in the mould of Leicester City, will increase. Teams will be much closer in terms of playing ability and medical/sports/data science. The paradox is then that luck plays a greater role than skill and anyone can win the title.

The same is true in sports trading. Every trader is looking for edge (at least, they should be). Wealthier traders and syndicates can afford the best technology, an ideally located server, the best mathematical and programming talent, hoovering up the loose volume before others.

Sports trading markets will become cornered by a select few, able to act upon information more efficiently than casual punters and the lone manual traders working from home. Increasing long-term efficiencies in data acquisition, processing and trading will mean that the big players make ever smaller returns until such time that luck alone determines which one makes a profit, if any of them.

There will still be punters having a flutter and naive beginners who think they can beat their technological superiors but, as with online poker, they will dwindle in number. Online poker is not as popular as it once was. Technology and skill have marginalised many and those that remain push money to and fro whilst the service providers rake it in.

Trading is like poker, as the winners depend on there being enough losers to reward their activity. To be a winning trader requires the best algorithms, coupled with the best equipment to give the best chance of winning. As traders become better informed and better equipped there will be a levelling out of trading ability and the gap in skills between the winners and the losers will decrease. Subtract commission and winning traders might not make enough to make trading viable.

Sports trading will go the way of online poker with luck playing a bigger role, even for the most skilled traders. Of course, certain vendors, educators and unreviewed video and pdf providers will deny the validity of this article. I hope that I have put forward enough logical reasons to demonstrate that the paradox of skill is true. So why bother trading? At present, the sports trading equivalent of the technological singularity has yet to arrive but that day will surely come.

There are still plenty of people on the exchanges who are still gambling; using hunches rather than back-tested strategies, using tipsters to do their thinking for them or using their gut feelings rather than their heads. Some get lucky and boast about their (soon to mean-revert) success online thus creating the illusion through survivorship bias that their techniques are valid. Such traders are the ones who compensate the real winners, those who consistently win through hard work.

Every day, there are more traders who become better informed as to the correct way to bet and trade, how to use the latest technology, who take up algorithmic trading instead of manual trading. There are also those who refuse to learn, bust out and are never seen again. Those who are pre-determined to fail will become fewer in number as the overall skill level of traders increases to such a point that it is hard for anyone to profit. In that instance, sports trading should be treated as a failing asset and dropped from the portfolio. Until then, get it whilst you can.

Further Reading 


The Success Equation - Michael Mauboussin

1 comment:

  1. I wanted to say thanks for writing your latest book, and this seemed as good a place as any.

    I've been trading algorithmically for 4 years and am always happy to buy any book that may be able to give me a sniff of an edge. I can now confirm that you are telling the truth when you say this book doesn't offer one, but it's reassuring to see so many similarities between approaches, and I would recommend it to anyone taking their first steps into algorithmic trading.

    In terms of this post, I can definitely confirm things are getting tougher all the time. My simple rules based code from 4 years ago has got much more complicated over time, but I'm currently making less with machine learning models than I was with the simple rules a few years ago. I always thought this an inevitable reality, but a few things do worry me. First, the introduction of the fee to use the betfair API can only reduce the number of new traders. Second, Betfair have a virtual monopoly in the sports exchange market, and whilst I have nothing against them, we are all at risk of changes to their terms (I may be doing BETDAQ a disservice, i haven't used their API for a few years). Whilst 10 years ago it may have seemed that the sports exchange was the future of betting, now it's not entirely clear if the sports exchange has a long term future, and it worries me every time I logon to betfair and realize that to a new user they're primary a sports book these days. This is one of the main reasons this remains a hobby for me.

    It appears that I've stumbled upon a community of like minded people, so whilst I have no desire to share what I think are my edges, if anyone's interested in sharing some notes, let me know!

    ReplyDelete