People often confuse investing and gambling but the parallels actually run deep. The confusion lies in comparing most forms of gambling – slot machines, roulette, lotteries – where the house sets the odds with those where the players set the odds. The house sets the odds in its favor. The house – not you – is guaranteed to win the longer you play.
Unlike most forms of gambling, horse racing odds are set by the betting public. The odds change based on where the money flows. In that context, understanding horse racing might offer some insights into investing, which is where this post is heading.
Steven Crist, of the Daily Racing Form, gave a speech at a Thought Leader Forum in 2007 on the similarities between horse racing and investing.
In horse racing, you are not betting against the house. In other casino games, you cannot win, with the exception of blackjack and poker. A good litmus test for someone being a liar and an idiot is if someone ever tells you, “I am really good at roulette,” or “I win at craps,” or “I have a system for beating the slot machines.” There is no such thing. There are games with fixed percentages. The casino might as well attach a leach to your forehead when you walk in the door because the longer you stay, the more you will lose, except for short-term, meaningless fluctuations.
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The reason that you can win at poker and horse racing is the same – you are not betting against the house; you are betting against the other players. This is such a crucial and fundamental difference, and it is lost on the general public. The house is not setting the odds. In roulette, there are 38 spaces on the wheel, and if you pick the correct one, the house, will pay you off at 35-to-one, and they will keep the difference. The longer you play, the more you lose, and the more the house wins.
When the other players are setting the prices, it is an entirely different story because somewhere between frequently, occasionally, and rarely, the public makes the wrong price. That is the beginning of the successful equation in horse racing.
Most people think they need to pick the winning horse when they really need to pick the horse offering the best value.
Most horse players spend their lives thinking that if they just studied a little harder or got a little bit smarter, they could pick the winner of the race enough to make some money. There is no such thing. Picking the most likely winner is no great feat.
What you really want to do is determine which most-likely winners are good prices and which most-likely winners are bad prices. It is a very simple equation:
Price x Probability = Value
The entire world of investing is that simple too. Here is what I mean. If a horse has a 33 percent chance of winning a race, and if you can get odds of 2-to-1 on him (which means tripling your money), there is no value – the horse is priced correctly.If a horse is 6-to-5 (which means you will only get back 120 percent of your bet) and he is only 33 percent to win, then he is a terrible bet. If you’re going to get 4-to-1 (quintupling your money) on a 33 percent chance winner, then it’s a great bet.
It’s also not about betting on every single race but only betting on races offering this.
What you wait for as a horse player (and investors tell me that they wait for the same thing) is mispricing, for the public to make mistakes. I cannot say for sure why the public makes mistakes in your world, but I know why they make them in mine.
Crist goes on to cover why mistakes are made (why mispricing exists). The first is relying on handicappers to pick winners instead picking value. Or more simply, taking advice from someone with a different motivation than yours.
The people who most influence the odds in racing are known as “public handicappers”. These are the guys at the local paper who run a set of picks every day. “Clocker Joe” or “Cowboy Jim” give you their 1-2-3 picks in every race. Their 1-2-3 picks have an entirely different motivation than your presumptive motivation to make money. Clocker Joe and Cowboy Jim want to pick the greatest possible number of winners so that they can remind their boss at contract time that they picked 31 percent winners in the previous year. that’s pretty good for a public handicapper. Yet, with a typical payoff structure, Clocker Joe will still have lost his customers money.
The next is simply misunderstanding how parts of the system work.
There is also a highly-misunderstood thing called “the morning line.” For every race every day, a track employee writes down a set of odds on each horse. These are not the actual prices that you get when you place a bet. They are the prediction of one overworked track employee for how the public is going to bet the race. The employee is not say, “I believe that horse #1 has a 20 percent chance of winning the race, so I will make him a 4-to-1.” He is in effect saying, “For a horse whose past performances look like this, the public is going to make him a 4-to-1 favorite.” Those are two extremely different things, and this is not at all understood by the wagering public at large.
And then there is the mistaken belief that certain people know the future (and might be affecting a horse’s price).
There is a mythical creature at the racetrack that is called, “They”. the vast majority of people playing the horses believe that there is a “They” – some cartel of brilliant analysts with foreknowledge of the outcome of the races, and when a horse is going off at much lower than his morning line odds, “‘They’ know. ‘They’ are betting today.” I used to believe in “They” when I first came to the racetrack, but the longer I hung around, the more I recognized that there is no “They.” “They” don’t exist.
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Be a contrarian. This is my nature. When someone tells me something, I immediately ask them what makes them think so or I tell them they are probably wrong. You can call it contempt and arrogance, I suppose, but I like to challenge what people say because they say things for bad reasons. I did not talk today about “inside information” in horse racing. Like “They”, inside information does not really exist…Nevertheless, participants in racing (owners, trainers, etc.) would rather steal a nickel than earn a dime. They all think that they’ve got big secret information. Just for the sport of it, I once kept track of a year’s worth of tips that I received – the ROI was horrendous, less than 50 percent. I worked at the tracks in New York for several years. They had betting windows on the back stretch just for the help and the trainers. Out of morbid curiosity, I looked to see how well those windows did – the take was much higher there than anywhere else at the track. I am personally skeptical of pronouncements by people who claim to have specialized knowledge because most of the time, they are saying it for reasons of ego – they want to look important, and I am immediately skeptical. It pays to be skeptical.
The biggest days – that bring in the most media attention – offer the best opportunities. And sometimes, the media hype train whips up a frenzy.
The worst players (the best players from our point of view) – the ones betting on names and looks and colors – have all left the race track…
However, the crazies do come back a few times a year. Kentucky Derby day, Preakness day, Belmont Stakes day, Breeder’s Cup day, almost every day at Saratoga, almost every day at Del Mar, the pools are filled with the money of tourists and amateurs – people paying attention to the selections of the public handicappers. It is really worthwhile to wait for those days and bet five times as much on those days as you would on a rainy Thursday at Aqueduct where you know that you are just playing against the other sharks. They’ll make some mistakes too, but there will not be a lot of fat in those pools.
There is another phenomenon about the big days and big races that is not only profitable, but also just as pleasing: once the general public and the media get involved in my little world of horse racing, the opportunities expand exponentially! They get it so wrong that there are wonderful opportunities.
Source: Steven Crist, Legg Mason 2007 Thought Leader Forum
