Why Care If Investing Is Parimutuel Gambling?

There is cheating in all kinds of gambling. But cheating in pari-mutual betting is different than cheating in gambling games of chance. Investing is pari-mutual betting. Investing is based on skill not luck. Investment scams work differently.

Market manipulation, insider trading, front-running, and banging the close. Why are all these things illegal in investing? We’ll see shortly.

Cheating and winning in probability gambling

The law of probability applies to totally random acts. When statisticians repeat a random act over a long time, they find out the odds for any result of that act. Many, many tosses of a coin are needed before the results of all the tosses average out to 50/50. And over time, the odds of a coin toss always do seem to average out to 50/50. For any particular toss of the coin, the outcome could be either heads or tails. Each side has an 50/50 (equal) chance of coming any time you toss a coin. Other random acts have different probabilities that can be known ahead of time.

In probability betting, because you know the odds of an outcome, an event can be rigged to change that outcome to one you can count on. A coin with one side heavier than the other is going to come up the way you want. The same goes for your loaded dice. These devices contravene the odds that everyone knows are set by the law of probability. These scams let you win without relying on “chance” or “luck of the draw” That’s why they are illegal.

Your best bet to win legally at pure probability betting comes from knowing the odds of your game. Different games have different odds. In craps, for example, there are different probabilities for the outcome of a 6 versus a 10 when two dice are thrown. (The 6 is more likely to happen because there are more ways two dice can add up to 6 than 10). Here is a table of craps odds. Using a strategy in craps (such as betting different amounts of money on different numbers) can help you, at least to lose less money if not to win more often, in this probability-based game.

Compare this to roulette. In roulette, knowing the odds means you will disregard those boards showing recent results that are hung near the roulette table. The odds of any color or number coming up in roulette are always the same no matter what numbers or colors just came up. The odds are 50/50. Your number/color either will come up or it won’t. Winning at roulette is just pure dumb “luck” on your part. Strategy won’t help you in this probability-based game. Those recent results boards are not information; they are devices to get you to spend more money.

Cheating and winning in pari-mutuel gambling

Pari-mutuel bets, on the other hand, concern events that aren’t purely random, and you can’t repeat them. Instead, bettors, or in this case investors, study the past trying to find similarities or trends that might be continuing, but there are no odds that can be set on the probability of the market going up or down at any moment. The likely outcome of the market can’t be calculated, only guessed at.

As a result, strategy is always a vital and big part of the game of investing. The stock market is a different entity every day. You have to figure out for yourself what is likely to happen.

At a racetrack, doping a horse doesn’t change the odds of any other horse winning. It changes the amount paid out to any winning horse. Cheaters may get more money by ensuring that one of the  horses does not finish the race. Because the race winners get everything in the betting pool (except what the track takes out for itself first), one less horse at the end means that more money gets split among the winners of a rigged horse race.

But doping a horse doesn’t guarantee that you’ll be one of those winners! It only guarantees that you’ll get more IF your horse wins. if your horse wins, you’ll get a portion of the bets the losers made on the horse that was doped. If your horse loses, doping the other horse didn’t do you a bit of good (unless you made a private bet that the doped horse would lose).

Deciding which horse to dope is based not on its “probability” of winning, but on which horse the doper believes most bettors will be putting their money on to win. As a result of the expected winner being eliminated during the race, the horses that now win, show, or place in the race will each pay out at a much higher rate than the odds on them would have indicated. This is why doping in racing is illegal.

In pari-mutual betting, cheating doesn’t rely on contravening the law of probability and changing the odds already given on an event (e.g., changing 50/50 on the coin toss to 100% heads); it relies on figuring out ways to get a bigger chunk of the pari-mutuel money pot for yourself. And this is exactly what scam artists in investing do.

Cheating in Investing

“Front running” lets a broker get more money than you do by investing their own and your money at different times. The broker buys shares of a stock before investing their customers money’ in that stock. Brokers invest customers’ money a little bit later. When all that money hits the market, it drives up the price/value of the broker’s shares. The broker then turns around and sells their own shares at a profit. The same trick works when the broker sells their own shares first when they know many of their customers will also be selling that stock.

“Market manipulation” aims at manipulating investors’ expectations to artificially push up prices. Manipulators might buy a small futures contract for a commodity at an unreasonably high price. This can get everyone else to start buying and selling at a higher price. When that happens the broker can sell their previous contracts at a much higher price than the market would warrant. Day traders in Norway were charged with manipulation recently for “outwitting the electronic trading system of a US broker.”

“Insider trading” is like horse doping. The winners use secret information to get a bigger piece of the pie. And “banging the close” (aka “tape painting”) is used by futures traders to make last-minute trades that influence the market just before futures contracts are settled.

Even the famed VIX indicator (‘the Fear Gauge’) is sometimes rigged by last-minute moves called “carpet bombing.” This is done by the big players to try to influence perceptions of investors about the amount of volatility in the market.

Investing is a game that is all about perceptions rather than probabilities. It’s about “smarts” not “luck.” It’s important for you to remember that. Winning at pari-mutuel betting requires learning as much about the game as you possibly can, even if, perhaps especially if, you entrust your money to someone else to invest it for you.

Copyright © 2010 Nancy K. Humphreys