“Once The Star-Spangled Banner began to play, I’d tell myself, “Here you go. Start pulling away, start computerizing. You must think clearly and remove yourself”...It was like watching a game through a window.” – Bill Walsh, Head Coach of San Francisco 49ers and creator of the West-Coast offense
A buddy of mine who knows how much I love sports analysis, sent me a website called WhatIfSports.com that runs mock simulations of games 10,000 times to create a projected outcome. Now I have no idea about the efficacy of WhatIfSports's Monte Carlo simulation, but I love this kind of stuff as anyone that has spoken to me about the chance of the Tarheels winning the National Championship in basketball can attest (we’ll save that diatribe for another blog). So, I decided to see what the best way to profit from this simulation, assuming it was accurate. I pulled up Vegas odds and Whatif’s NFL week 8 projections to see if I could find any inconsistencies and did a quick analysis:
Based on this, Vegas was pretty much dead on, but not perfect. How would I profit from these mis-priced games? I would definitely bet the under on the Falcons/Saints, because Vegas has the game total at 54 and WhatIfSports has the total at 45. I would also pick the Rams getting 9.5 points over the Lions, when WhatIfSports has the Rams winning outright. I may also pick the Broncos and 49ers, but I would not be as confident and would certainly place a smaller bet on those games. This got me thinking about how this analysis applies to investing.
If I am evaluating a basket of stocks for potential investment, the Vegas Odds are the current stock price because they indicate what I can “buy” the bet for today and the WhatIfSports analysis is my proprietary research. I want to find the assets with the biggest differentials, Falcons/Saints under and Rams and make big bets on them. If I find other stocks with a reasonable difference between the market price and my calculation of value then I will place a bet on them as well, but not to the same degree as the large spreads.
If I’m an investor, how can I determine which assets should go in my portfolio and how to size them without calculating the risk-adjusted return of every investment? I must measure the difference between the market price and what I think the value is to determine the attractiveness of the bet. This concept seems so straightforward, yet most investors are willing to allow their mental calculator to be the final arbiter of portfolio inclusion and position size. That’s just like looking down the list of Vegas Odds and saying, “hmmm, I know the Saints score a lot and 45 isn’t that high, I think I’ll take the over.” First off, our brains are not very well designed to make those kinds of decisions, just read any book on behavioral finance or neureconomics. Second, even if you are right in your assessment that it is a good bet, how do you know exactly how good it is. Is it pretty good, really good, or freakin’ fantastic? Those differences affect how the position should be sized.
No doubt, calculating risk-adjusted return is harder than not calculating risk-adjusted return. But honestly, there are millions/billions of dollars at stake. How do you know what to bet if you don’t know your own spread?
So, wish me luck this Sunday and GO RAMS!!!