Before diving into a political betting site with your first trades, you might want to understand how prediction markets work and why they’re gaining popularity around the world. So here’s your Prediction Markets 101.
A prediction market is based on predicting the outcome of a binary event, meaning something that either will or will not happen. When you make trades in the stock market, you’re betting your money on a payoff that will vary depending on the outcome of future events, but with a prediction market you’re trading on the results of a future event structured so that you receive $1 per share if the outcome materializes and $0 if it doesn’t. With enough involvement, the value of a bet will reflect the probability of an outcome.
For example, in a market for if Candidate X will win an election, if it’s trading “yes” at 70 cents, that means the market is predicting there’s a 70 percent chance that candidate will win. As time goes on, the market can fluctuate as conditions and the combined information of participants changes. In a prediction market, you can leave the market and “cash out” your winnings (or cut your losses) at any time, even before the event takes place. This is a major distinction between prediction markets and futures trading on the stock market where you’re locked into your position until the agreed upon closing.
Predictive markets rely on the collective information and decision-making of crowds of people, and can lead to more efficient and accurate results than traditional political polling, which relies on a snapshot of information from a self-selecting group of people. Scientists who have evaluated predictive markets see mounting evidence that “such markets can help to produce forecasts of event outcomes with a lower prediction error than conventional forecasting methods.”
The general assumption is that a wide group of people, with different expertise and experiences, holds more information on any given market than individuals would on their own. Participants in prediction markets like PredictIt are also putting down real money towards what they believe will be the outcome, not what they may personally want. This creates added incentive to gather a lot of information to make a prediction as accurate as possible, and to continue to track the event as it unfolds over time.
The 2020 presidential election shows how election prediction markets can be more accurate than traditional polling.
In the days just before Election Day, traditional polling outlet FiveThirtyEight had Joe Biden’s odds of winning at a staggering 90 percent, while PredictIt (which is one of the only political betting sites and prediction markets cleared for trading by the Commodity Futures Trading Commission), had the odds of Joe Biden winning at 63 percent, while Donald Trump’s odds inched up slightly to 40 percent. This trend reflected more accurately Biden’s narrow lead in key swing states as well as diminished support we saw for Democrats in down-ballot races.
In summary, political betting and prediction markets can be incredibly useful in showing public trends when enough people are involved and bring their experiences and knowledge. We will undoubtedly see their popularity continue to grow through the 2022 midterms and 2024 presidential election.