Why Long-Shot Bias Creates Easy Wins in Prediction Markets

Folks aren’t always rational when it comes to probabilities.

Yet some of the best opportunities I’ve found have come from taking the other side of the trade when the crowd becomes too convinced about a particular outcome.

And it doesn’t just apply to the stock market.

You see it in horse racing, sports betting, and even the lottery. Despite the odds being firmly stacked against them, folks are attracted to the possibility of a life-changing payout.

A long shot offering a huge payout can be far more appealing than backing the favorite for a relatively modest return. And when enough people become drawn to those big potential payoffs, the odds can get distorted.

That’s where things get interesting for a trader like me…

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Possibility Versus Probability

Market veterans refer to this phenomenon as “long-shot bias.” At its core, it describes how people can overvalue unlikely outcomes because of the possibility of a huge payoff.

Crowds grow so focused on the potential reward that they stop paying attention to the odds.

For example, a lottery ticket can win. So can a 100-to-1 long shot down at the track. And in the markets, a stock could double or triple. But just because something can happen, it doesn’t mean it’s likely to happen.

Yet people imagine how much money they could make rather than carefully considering the odds of that outcome actually occurring.

That can lead them to pay far more than the opportunity is really worth. For example, if the market is pricing in a 10% chance of an event happening and I believe the real odds are much lower, I’ll consider taking the other side of the trade.

To be clear, it doesn’t mean that every long shot is overpriced or that backing the favorite is automatically a good trade. What matters is the relationship between the probability of an outcome and the price you’re being asked to pay.

That’s a distinction I’ve spent much of my trading career looking to exploit. And it’s something that drew me to the prediction markets…

How Prediction Markets Reveal Mispriced Odds

One of the things that has really caught my eye with prediction markets is how they allow traders to express a view about the likelihood of a particular event.

Contracts might focus on where Bitcoin is trading at the end of the day or whether the Federal Reserve will increase rates at its December meeting. The price of the contract reflects the probability that market participants are assigning to that outcome.

And when those probabilities and the likelihood of an event don’t add up, that gets my attention. When these probabilities become too disconnected from reality, we can profit. Taking advantage of those opportunities has enabled my Prediction Profits members to snag 11 winners from 12 closed trades since launching in June.

And that’s just the start. There are far more opportunities out there… including in sectors like technology.

That’s why I’m so excited about this growing space. And why I’m so keen to share how you too can get involved.

At 8 p.m. ET tonight, tech expert Jeff Brown and I are holding our Penny Tech Profits event.

We’ll show you how we’re looking to use prediction markets to target trading opportunities in the technology space. What’s more, we’ll even place trades on camera to show you how we put our strategy into action.

I’d love for you to join us. All you have to do is RSVP with one click right here to attend.

Happy Trading,

Larry Benedict
Editor, Trading With Larry Benedict