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Prediction Markets are all Priced Wrong | Bitcoin Trading Challenge | YouTubeToText
YouTube Transcript: Prediction Markets are all Priced Wrong
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Core Theme
The core theme is that current prediction markets are fundamentally mispriced, particularly those with high implied probabilities, due to overlooking crucial factors like the bankroll effect, optionality, and path dependency, which significantly impact real-world trading outcomes and trader psychology.
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Hello traders. This is going to be such
a fun video. Really, really, really
looking forward to this one. I have a
bold theory and I'm going to invite you
to join me in this bold theory. You
might agree, you might disagree, but I'm
going to present the facts and we'll go
from there. I believe that right now in
2025 about to be 2026 we are all
thinking about prediction markets
completely wrong. I think that the
actual pricing for prediction markets
100% is actually all incorrect. Let's go
into it. First thing that I want to say
is well two things. First of all uh
where am I coming from? I love trading
on on Kelshi and Poly Market. This is my
P&L on Kelchi. You can go look me up.
I'm Bitcoin Trading Challenge. All of
this profit has come in two months. So,
I've been uh making some pretty good
income. A lot of it has been in sports
and in crypto markets on Kelshi. Now, I
am super super super excited to announce
that I have a new partnership with a
company called Slice. This is a platform
that sources the best traders, gives out
all of their private alpha. And if you
are interested and you click the link in
the description below, you will get all
of my thoughts in the market, high alpha
articles, and direct engagement with me
as well. I also have a 70% off promo
going on right now that is first come
first serve. So, if you want to go check
it out, it's just a really cheap way
that you can get access to alpha that I
would rather keep uh you know, gate locked.
locked.
All right, with that out of the way,
definitely go check out Slice and let's
go in.
So the also this is what slice looks
like. Do poly markets or prediction
markets actually represent probability?
I want you to imagine that we are
watching a sports game where we can buy
at 98%. You look at an external sports
book and you see that the true odds the
true value uh the true probability that
that this is going to happen are also 98%.
98%.
Our bet guys has neutral expected value.
We are not expected to lose money or
make money over time, right? Well, I'm
going to invite you in to take a look at
a Monte Carlo simulation of this play so
we can see our P&L over time.
How often does our 1500 bankroll stay
above 980? Why did I pick 980? Well, I
want you to imagine a scenario where we
are buying 1,000 shares at 98%. That is
a cost of $980.
Now I want you to also imagine that we
have a total bankroll of 1,500. So we're
risking 980 to make 20. We're buying at
98%. You know, you get it. And our
overall bankroll is 1500. Now this shows
you over time. I did tons of simulations
and here is the average.
This is bizarre, guys. Seriously. I mean
look at this. Over time, you will very
very very very very likely uh not be
able to have even over $980 in your
account um by a certain amount of
trades. But why is that? I did this
simulation where I'm buying at 98% guys
and guess what? Um the odds are 98%. So
I should be winning, you know, $20 98%
of the time. However, even with a few
trades, you can see just how quickly we
go to a 50% probability that you will
not even have one bet of $980
on a $1,500 $1,500 account. Um, even
over just a few dozen trades. The more
trades you take, the more likely it is
betting that size of your bankroll that
you will not have enough to even place
one bet of a thousand shares at 98%.
Why? This is called the bankroll effect.
This is the first reason why I think
prediction markets are all priced wrong.
Look, if you lose 50% of your account,
which in this case it would be an even
larger loss. But if you lose 50% of your
account, like let's say you go from one
grand to $500, you know, you got to make
an 100% profit in order to get to get
back to break even. 100% profit on a
$500 account, you have now account of
a,000, which is what you started with.
This can be mitigated buying high odds
can be mitigated by just not betting
more than let's say 20% of your bankroll
but the effect of a loss on your
bankroll is still going to be quite
massive due to the high odds that you
purchased. Moreover, and maybe the most
important part here guys, emotions. Do
you know the emotional effect of losing
such a substantial part of your
portfolio? For example, here, if you
lose this bet where you buy at 98%. You
lose $980 on your $1,500 account, will
you really be able to stay level-headed
and still take plus EV plays? No. I
think you would likely have a negative
edge. Uh, you would over gamble and you
would be pretty much engaging in minus
EV, also known as negative expectancy
behavior. The first reason why I think
that prediction markets should not be
priced the way that they are, such as a
90% chance represents a 98 a 98 uh
percent chance for true odds. This is
the first reason.
Second reason, optionality. If you buy
at 1 cent, a lot of the times, did you
know you can actually sell back at one
one cent for no loss? If I'm first in Q
at 1 cent and I get filled on a
prediction market, I can wait for things
to play out and then just sell right
back at 1%.
You can't really always do that when you
buy at 98, right? Sometimes you can, but
not always and the risk is insane. So if
you buy at say 3 cents, you can sell at
five, you can sell at two for a slight
loss. There's so much more optionality
here. On the contrary, we just don't
have a lot of optionality if we buy at
97 when it comes to expected value.
Guys, if you buy at 97 cents on a
prediction market, if you sell at 98, do
you know what you just did? You just
risked 97. So, let's say it's a,000
shares. You just risk $970 in order to
make 10. That's not a great riskreward,
right? So, we don't have as much
optionality when it comes to buying
incredibly high odds. And let's say that
if we were to even take a slight loss by
buying on high odds. Well, if you buy at
97 and try to sell at 96
already, you have so much capital at
risk that it just all isn't really worth
it, even if you're just going to have a
$10 loss. Also, liquidity, you might not
even be able to sell. So, buying cheap
odds gives you fantastic optionality
where you can sell at no loss, you can
sell at fantastic profits, like a double
within seconds. Um, you can't really
double your money if you're buying at
80%. high odds, right? This is a reason
why I think a lot of these prediction
markets are not really pricing things properly.
properly.
Third reason and the most important by
far. Um, well, bankroll is pretty
important, but this might be the main
reason I think path dependency. So, two
bets with the same probability can have
just radically different trading
outcomes depending on price movement,
draw down, and opportunity costs. So
there are so many examples of this, but
let's say that you buy at 90%. Let me
give you two different scenarios of what
can happen to you. You buy at 90% and in
one scenario you cleanly go up every day
and it goes to 99 and the market gets
resolved. You win. You walk away and no
one really cares. The other scenario,
imagine that you go from 90 to 62. [sighs]
[sighs]
And now you have a substantial part of
your portfolio in this. you're feeling
very emotional and kind of feeling like
you want to sell. So, let's say you sell
a little bit and then price actually
goes to 100%. Because you derisked,
uh, you're going to be end up losing
even though you bought at 90 and it and
it exited at at 100%. Because you
d-risked a bit, your overall P&L is
going to be negative. That is completely
different, guys. That's what path
dependency is. So, probabilities
currently on prediction markets are are
sort of ignoring this. Lower probability
options tend to have much better paths.
Such as if we're buying at 1% guys, does
it go to four? Does it go to five?
Whereas if we buy at 99%.
The paths that the 99% can take are
typically pretty abysmal. Right? And
also when you buy lower probability
options, it tends to lead to far less
emotional trading. Guys, if you buy a
thousand shares at three cents, that is
a cost of $30, which for most people in
Poly Market in Koshy isn't really much
of a sweat. A $30 bet. If you buy at
97%, that's a $970 cost. That's a bit
more of a sweat, right? So, if a trader
buys at a high probability and the
market turns against him, there also
might not be enough liquidity for you to
even exit or derisk. When you buy at low
probabilities, what I have seen is
there's typically a lot of liquidity
because it's cheap. You can put out
10,000 shares at one cent, guys. People
don't always put out 10,000 shares at 82
cents, right? If the market's trading at
90 because 10,000 shares at 82 cents is
8.2 grand cost. 10,000 shares at 1 cent
is a hundred bucks. Yeah. Completely
different scenario. Seriously. So there
might not even be liquidity for you in
uh the path if you buy at a high
probability and try to derisk your
ability to flip for profit, cut losses
cheaply, reposition at better odds. Uh
great example of that. You buy at 5
cents, you sell at four, you reby at
two, that's a good trade as long as we
go up from two, right? It this all
depends on how prices move before
resolution. And a lot of markets are
just not factoring in this case at all.
Here's a really cool example to show you
how prediction markets should be priced
if they were hyper hyper hyperrational.
4 cents to 8 cents. You have just bought
at 4 cents with the plan of holding
until your limit sell at 8 cents gets
filled or you lose your entire bet. You
have put in $100.
If there is a 55% chance that you get
filled at 8 cents, this play is
incredibly plus EV. Look at the Monte
Carlo average cumulative P&L graph we
have here. This is 100 simulations of
100 trades. Super simple. Where the
probability of a win is a 55%. Because
you know, I wrote that in there.
Probability of a loss is 45% and you
know the stake, the win, and the loss,
right? Buying at four and selling at
eight, by the way, is a double of your
money. $100 turns into 200 over time. Uh
this is so plus EV you would be printing
money uh just the more trades that you
take. Right now I want to ask you
something. Do you think that in most
scenarios when you buy at 4 cents is
there a greater than 50% chance that
you'll be able to sell eight? If there
is then the market's mispriced
especially in sports markets too. If in
a lot of sports markets it's so easy for
you to flip your trade from 4 cents to 8
cents, then these markets shouldn't be
trading the way that they are, right?
Another example of why this is actually
happening. Well, on a sports book, you
can't really take profit, guys. If you
buy at plus 500 odds, your cash out
price is going to be abysmal no matter
where price goes, right? Because sports
books have a very high vig. So, if you
try to actually cash out, uh, you're
going to be losing a lot of EV. In
prediction markets, there's no VIC. It's
just whatever price you want to buy or
sell at. So, here the game is a bit
different. And this is just another
reason with path dependency and actual
probabilities of doubling versus losing
at all that these markets are all
mispriced, guys.
So, finally, exit uh versus final
resolutions. A lot of traders these days
aren't actually going to hold until
resolution. Go look at volume versus
open interest. You're going to see, man,
that a lot of there's a lot more uh
volume relative to the open interest of
the market, showing people are trading
far more than they are holding till
expiration. People are trying to flip,
right? Therefore, the price should
reflect the probability of being able to
exit at a better price. For example, the
percent chance of odds going from 4
cents to 8 cents and not the probability
of a final outcome. Okay? A contract
should be overpriced relative to final
probability but underpriced relative to
expected future trading range. I know
that is very very very complicated but
let me just make it super super simple
for you. A 4centent contract right that
has a 55% chance of going to eight
should not be priced at four. It should
actually be a little overpriced. It
should be maybe at like 4.5 4.4. That's
what the theoretical value of the
contract should be. Right? So that's the
way that these markets should run, but
they're not really because markets
should be pricing tradability, not the
truth of what's actually going to happen
in the market. Uh, another reason that
this is all a little bit muddy is
because of interest rates. If a
prediction market expires in one year,
it should absolutely not be trading at
99 cents because you would be a fool to
buy at 99 even on a absolute 100% given
outcome where it says this market will
resolve to 100% if we are solvent no
matter what. You should never be buying
99%. Because you can make far more than 1%
1%
um anywhere else in 365 days. So that's
another reason why markets shouldn't be
priced as high as they are, you know,
when they're longer term. What does all
this mean? There's no perfect way for me
or you to price a market on poly market.
We're not supercomputers, right?
However, a market that expires in say
half a year that has inherent true odds
of 98% should absolutely not be traded
at 98% by any rational market
participant. This is going to be due to
interest rates, but other reasons too.
the optionality of buying cheap, ease of
cutting losses when you get those cheap
odds, the bankroll effect, i.e. if you
buy at 2% and you lose, no one cares. If
you buy 98% and you lose, you die kind
of. Uh, and the overall emotional
well-being, ability to make plus EV
decisions when you buy cheap odds versus
expensive. I don't know about you, but
when I buy at 2 cents and it goes to
zero, I don't really care. It's
expected. If I buy at 98 cents and it
goes to zero, my ability to make good
decisions is probably going to go out
the window. Wouldn't you say so? So that
is just something that I wanted to
share. Uh these are the three reasons
why I think that absolutely um
prediction markets are all mispriced
especially sports markets that are just
taking in the API of sports books and
just reflecting those improbabilities. I
think that there is too much that in in
the history of a lot of markets too much
of the time uh prices are actually not
going to just go to 90 and then slowly
go up to 99. Uh a lot of them are a lot
more volatile than that. And this is
basically a presentation on showing you
that you know the volatility and the
path dependency of these markets matters
a lot more than the true inherent
probability uh you know at the absolute
final. So, this is something that I
wanted to share with you guys. I've had
this idea for a while that all of these
prediction markets are pretty much
priced wrong. And I've been able to make
uh, you know, dozens of thousands of
dollars so far. Uh, basically exploiting
the fact that these probabilities are
just completely uh, wrong a lot of the
time. And I'm I'm really interested to
hear what people like Domer and other
top uh prediction market traders think
of this about the path dependency, the
bankroll effect, the optionality, time
value that uh a lot of the times markets
should never be trading at 98.99 unless
their true odds are far far higher than 98.99%
98.99%
and the expiration's within a day or
around there. Finally, I also have a buy
me a coffee if you're curious about the
two different platforms. Slice. If you
want my thoughts in the market, high
alpha strategies, buy me a coffee is
fantastic. If you want my live streams
and my articles, whatever you pick, I'm
happy. Happy trading everybody. And
thank you for sticking with me on the
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