Tuesday, 25 March 2008

The Application of the Dornbusch Overshooting Model to the Betfair Golf Market

Firstly, I apologise slightly for the forthcoming post. I feel like I have learnt an unbelievable amount from trading the golf over the weekend and I’ve decided to share my thoughts on the blog. I did think about not sharing these thoughts on here as I know that others can ‘piggy back’ on my findings but being honest, I don’t think one weekend’s trading on golf makes me an expert, so I don’t think other golf traders have much to worry about!

OK, so what is the Dornbusch Overshooting Model?

To quote from Wikipedia, “The Dornbusch Overshooting Model aims to explain why exchange rates have a high variance. The financial market will initially overreact to a change in money in order to achieve a new short-term equilibrium, but over time goods prices will also respond, allowing the financial market to dissipate its overreaction and the economy as a whole will settle on a new long-run equilibrium.”

In layman’s terms, the Dornbusch model was an attempt by an economist to explain a phenomenon that was always witnessed in the exchange rate market. Basically, when something occurred in the economy (for example a change in interest rates), the exchange rate market would have to adjust accordingly. However, the exchange rate market would always over-adjust to the change in the economy and then over time, the market would adjust to reach its new equilibrium.

Anyone reading this may be thinking, “What the hell is Graeme talking about tonight?”

Well, after watching the golf market very closely over the weekend, I’m 99% certain that the Dornbusch theory applies to the golf market on Betfair.

I’ll try to explain what I mean. I spent 2 days trading Tiger Woods’ odds movements and once I’d picked up on this phenomenon, it became quite easy. In the golf market, a player’s odds will move every time that they strike a ball. In the early holes of the tournament, their odds will only adjust for birdies and bogies etc. but in the final 2 rounds of the golf tournament, the odds on a player will move every time they strike the ball. This is especially true for someone like Tiger Woods……

I think there was something like £8m matched on the golf tournament. Around £5m of this was matched on Tiger Woods alone which is an amazing amount on one player!

So, what exactly is it that I noticed this weekend? Well, every time a player makes a good shot, the market automatically over adjusts and all of the available odds are snapped up by backers down to a certain price. However, after 5 seconds or so, the market slowly adjusts upwards and the back price is pushed up as the layers start to lay the odds which have become too low.

The phenomenon is even more apparent when a player makes a bad shot. I had to rub my eyes some of the time when I could see what was happening in the market. I really couldn’t believe it and being honest, I didn’t exploit it even close to where I could have. I was more interested in watching what was happening instead of trying to exploit it as there will be plenty of chances to put what I have learnt into practice in the future.

I took notes on numerous examples but I don’t want to bore everyone with examples and graphs, so I’ll talk through 2 specific examples.

Good Shot Example

Furyk was trading at 28 with around 4 holes left. He was 3 off the pace. He played a good shot into the green and was left with a very good birdie opportunity. His odds moved from 28 to 8 and within a few seconds, all of the available 8 was snapped up down to 7 and he settled there. He then made his birdie putt. Within 5 seconds of making the putt, he was trading at 16! All of these odds were available for £50 plus, so it’s not like I’m talking £2 stakes. It doesn’t take a genius to work out that the market had over-reacted to his shot into the green and the odds of 8 were far too low.

The amazing thing from what I could see is that traders couldn’t recognise that 8 was a false price and were snapping up the 8 and lower! 16 was the correct price and the market quickly adjusted to this price after 15 seconds or so after he made his putt. I could have laid £50 at 8, backed £50 at 16 and hedged for a £25 profit. This could have been done in the space of 2 minutes.

Bad Shot Example

I struggled to believe my eyes with what happened here! Vijay Singh was 2 shots back with 5 to play. He was trading at 12 or so. He had bogied the previous hole and appeared to be going through a sticky patch. He dropped a shot on this hole also and this meant he had dropped shots at the last 2 holes and was now 3 back. OK, he was 3 back with 4 holes to play, but clearly, Ogilvy was not going to birdie any of the remaining holes as he was getting tight, so Singh wasn’t out of it.

Walking off the green, Singh was available at 200 for £10. Once someone had snapped up this amount, he was available at 250 for £50! I stared in disbelieve……

Before I could click the mouse (I wasn’t on Bet Angel Pro), he was trading at 50. He then went on to birdie 2 of the next 3 and was trading at 10 on the final hole for large sums and could have been laid off easily at 11.

By the time I had realised what had happened, I was kicking myself for just watching it and not taking advantage of the situation.

Without teaching anyone to ‘suck eggs’, I could have snapped up the 250 for £50 and then laid off £50+ at 50. I could have then laid off the remaining amount at 11 or just let the free bet run. He finished one shot behind Ogilvy and could have made a playoff!

So, my main learning from this weekend is that the golf market over-reacts to the shots that the players make. I’m going to spend some time over the next few weeks developing a strategy to try to exploit this situation and once I’m comfortable with my strategy, I can look to increase my stakes and exploit the situation fully.

There are other numerous things I’ve learnt from watching the golf closely this weekend. Here’s a question for everyone who watched the golf this weekend:
What did Vijay Singh, Jim Furyk and Retief Goosen all have in common this weekend?

· Last year, they were all in the top 10 in the world. True but so what!
· They all finished tied 2nd at this weekend’s golf tournament. Again, true but so what!
· They were all matched at 1000 on Betfair during the tournament for £50+ and they were all matched at 5 or less during the final round for huge sums. Clearly, some people made an absolute killing from these players and this was simply due to the market over-reacting to the fact that Tiger Woods was top of the leaderboard during round 2.

There were also simple lay opportunities to trade on Tiger Woods if I had a larger bankroll. For example, when Tiger Woods had finished his round, he was trading at 200 on Betfair and people were snapping that up! He was 2 shots back and in 5th place with no holes left to play, he should have been a 1 million to one shot and not a 200 shot. After a few minutes of people snapping up the 200, he was available at 1000 for a huge sum and the opportunity was gone.

Overall, I feel like I learnt a huge amount from the golf this weekend and I’ll be hoping to use some of these learning’s in my future golf trading.

At the end of this month, I’ll discuss where I see The Experiment going and provide a review of the 1st month. I’m trading Tuesday, Wednesday and Thursday on the horses this week, so I’ll look forward to that again.


Cassini said...

Graeme - interesting read as always. One comment: the price on a player is influenced by factors other than his own play - namely other players. In your example of a good shot, it is possible that his good shot happened to occur at the same time (or within seconds) as a 'bad' shot by the leader and so the odds moved because of two events, not one. But your observation that the market moves too sharply is correct and this can be seen in other markets all the time. Greed and Fear drive the market. Essentially what happens is that, for example, Tiger makes a 20' birdie putt and the greed kicks in. "Have to be on Tiger whatever the price!!". Then reality sets in, and the realisation that your 'investment' is now just one errrant tee shot away from disaster sees the fear element kick in, and the price moves back. May I recommend a book to you: Trading Your Way To Financial Freedom by Van K Tharp?

Graeme Dand said...

Thanks Cassini.

I had a quick read again of your first post on your blog and I agree 100% with your observation that fear and greed drives the market.

The weekend’s golf tournament probably taught me more about this than I could have ever imagined.

I think it’s simple demand and supply theory in the market. As you say, when Woods makes a good shot, backers are willing to back Woods at any odds they can get up to a point. However, the layers then realise that the market is not at its correct equilibrium and the market then slowly slides along the demand curve to a new equilibrium at a higher price.

Basically, I think there is an opportunity to trade purely on the market adjustment after a shot has been played. This market adjustment is based purely on the fact that people are happy to back and lay at the ‘wrong’ price simply because they are driven by greed and fear. Once the realisation kicks in, the market slowly moves a few ticks in the opposite direction.

I’m not saying that this is easy and I’m sure it will take me weeks or maybe months to get to grips with what happens but I think the key thing for me is that I have identified something that I think I can explore further and maybe look to exploit. This has obviously got me excited as it’s something that can be mastered which has a huge upside and little downside. If the market doesn’t adjust every time, I can just bail out with a break-even or a small loss on the trade.

This has given me food for thought over the next few days…….