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Econ Grapher currently publishes the Econ Grapher blog. He previously worked in markets, trading, investment management, and corporate strategy. He has also set up two internet research businesses in stock research and economic research.
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• ##### Playing The Prediction Markets
This article provides an introduction to both utilising predictions found in binary option prices, as well as some pointers on trading. Prediction markets provide an interesting venue for gauging the probability of an event based on the trading of both informed and uninformed participants.

As an investor, trader or someone with a general interest in things like economics related events you can use prediction markets to help get an idea of the probability of an event occurring. You can then take it a step further and take potentially profitable positions if your view on the probability contrasts with the markets’ view of the probability.

Prediction Markets and Binary Options
So what are prediction markets? Prediction markets generally involve the trading of binary options. You may know what options are (the right but not the obligation to purchase a given thing), and the benefits of using them (nonlinear payoff profile i.e. fixed premium/cost vs variable profit). But binary options work a little differently, the standard binary option pays \$1 if a specified event occurs by or on a specified date – otherwise it pays \$0.

For example ipredict has a contract on the US Federal Reserve increasing interest rates by November (here): “FED.INCR.NOV10”. This contract pays \$1 if the Fed increases interest rates on or before the 4th of November 2010.

You can both sell and buy binary options. So using the previous example, if you believe the probability of the US Fed increasing rates on or before the 4th of November is greater than 0 then you would buy contracts (e.g. if you bought a contract at \$0.50 and the Fed increased rates before expiry you would receive \$1).

Likewise if you believed that there was no way the Fed would lift rates this year then you could sell short the contract. So for example if it were trading at \$0.50 then you would sell a contract for \$0.50 and on expiry if the event did not happen you would get to keep the \$0.50. But of course the converse is true, if the event did occur then you would have to pay \$1 to the holder of the contract, but this would be offset by the \$0.50 you sold it for.

How to Read the Market Predictions
So by now you probably can already answer this question, you gauge probabilities based on the price. If the price is \$0.50 then on average the market is pricing in a 50% chance of the outcome.

To look at an example, on ipredict there is a suite of contracts on the RBNZ (Reserve Bank of New Zealand) interest rate decision on the 11th of March. At the time of writing the approximate prices of the contracts were as follows:

OCR.NC.11MAR10 Price \$0.9650 …therefore probability = 96.5%
OCR.25.11MAR10 Price \$0.0300 …therefore probability = 3.0%
OCR.OTH.11MAR10 Price \$0.0050 …therefore probability = 0.5%

So at the moment you can see the market is overwhelmingly expecting no change to the Official Cash Rate on the 11th of March. You can see how the probability aspect works with this suite too by noting that all outcomes (all mutually exclusive and exhaustive) add up to 100%.

How to Make Money Playing Prediction Markets
So now, down to business! I bet most of you have already started plotting how to make money, but this section sets out the basic strategies for making money by playing the prediction markets.

1. Positioning
The first way is what I call positioning. Basically you find contracts where you’ve got a strong opinion on the outcome, and position yourself to profit from that view. For example with the Fed rate increase contract, if you believe there’s about a 70% chance of it happening then you would buy it all the way up to \$0.70 (or possibly higher).

But it's important to think about the risk and reward profile e.g. if the price is \$0.70 then your profit, if it happens, is \$0.30 (\$1-\$0.70=\$0.30), but if it doesn’t happen you lose the \$0.70 you paid to buy the contract. This is a sub-1 trade; the ratio of profit divided by loss is 0.43. When you play sub-1 trades you need to get it right to make money.

A 10+ (ratio) trade on the other hand gives you a higher margin for error, but at the same time is the result of the market ascribing the outcome a low probability. For example if the price is \$0.05 the profit-loss ratio is 20, so in trading it, for an expected breakeven you could afford to be wrong on long positions in this contract 19 times out of 20 if the position size is the same on all trades. But again, the probability according to the market is 5% so you need to study up and try and foresee what the market doesn’t.

Another way of making money is utilising the fact that prices are determined in a liquid market with at least some informed participants. So as new information is revealed the price will change. For example if the price of the US fed rate increase contract is e.g. \$0.20, and then an inflation report comes out showing a huge upside surprise then the price could rise to, just for example, \$0.30. In that case you could close out your position at a \$0.10 profit.

You can play these sort of trades quite speculatively around interest rate announcements e.g. if you have a tightening bias you could buy a later contract e.g. April, as a play on any hints for a sooner increase coming from a sooner interest rate announcement. Anyway there are all sorts of market trading strategies you can use for actively buying and selling binary options.

3. Arbitrage
Sometimes arbitrage opportunities will open up in suites of contracts or between similar contracts. There will be times when you get quasi-arbitrage from contracts that have very similar payoff profiles, but might be structured slightly differently.

Anyway the easy way to arbitrage between contracts where there is more than one out come and you have mutually exclusive and exhaustive contracts is as follows:
a) Bid side: add up the bids, if the total is greater than \$1.00 then sell an equal amount of all of the contracts.
b) Ask side: add up all the asks, if the total is less than \$1.00 then buy equal amounts of all contracts in the suite.

Example: a suite of 3 contracts has the “ask” as follows; \$0.9005, \$0.0890, \$0.0075, the total of the “asks” is \$0.9970, so you could buy all the contracts for \$0.9970 and receive \$1 at expiry/event date, thereby netting \$0.0030 (or net \$0.30 for 10 contracts, or \$3.00 for 100 contracts, etc – to illustrate).

Summary
So there you have it, you can use prediction markets (aka binary options) to get a reading on the views of a market of informed and uninformed participants of certain events happening. But more importantly you can use these markets and instruments to make profits by taking positions on certain outcomes you have knowledge about, or by actively trading in the market, or even through arbitrage.

Article Source: http://www.econgrapher.com/binaryoptions.html

Notes:
I have only used this provider: www.ipredict.co.nz But I am aware that there are other providers out there, and a quick google search should reveal them. Also note this is not to be construed, or relied upon, as advice. I have no association with ipredict, but I do trade on the platform, and from time to time I do take long and short positions in contracts that trade on that platform.

Disclosure: I have long positions in RBNZ tightening contracts. From time to time I will take long and short positions in the contracts mentioned, as well as other contracts on ipredict.
Mar 03 11:04 PM | Link | Comment!
• ##### Social Media for Economists: Part 2 - Publishing and Promoting
In the previous article of this two-part series we talked about how to tap into social media sites for research purposes and connecting with interesting people that have interesting things to say. This time the emphasis is on the other side; publishing and promoting. This is about how to publish your articles and then distribute them to the widest audience possible, and to ultimately build your personal brand. Just remember though, promotion doesn’t beat good content; while it’s good to spread the word, make sure it’s worth spreading.

We’ll look at it in two parts: first we’ll look at where to publish your articles. This will include various blogs and media sites that allow you to contribute articles. Then we’ll look at how to tell people about your articles and how to get links up. It’s possibly a little overkill to use every single one of these, so it’s up to you to find the right mix. You don’t want to be seen as spamming, but at the same time you want the maximum amount of people to see your stuff and find out how smart you are and hopefully start following you.

I guess you need to quickly review your own goals. Is it to build maximum brand recognition? Is it to build maximum amount of links? Is it to go for credibility first? Is it simply to reach as many people as possible? You need to have your aims at least somewhere in your head so that you can best execute your article distribution and promotion plan.

Similar to part one of the series on social media for economists, I’ll review some key websites and assign a score out of 5 for effectiveness, and of course a paragraph on how to get the most out of it and a few tips and hints.

The first place to start is to build your own website, or blog. If you are not very tech savvy it may pay to go for a blog. Blogs are a dime a dozen these days, and many services offer them for free. Google has their own service called Blogger. It is relatively easy to use and fairly common too. Plus it has social features in that people can follow you, and comment on articles. Of course there’s also the ad sense bit so you could make a few cents here and there. I would say having your own blog is a must as it gives you a sort of home base.

Seeking Alpha – 5/5

Motley Fool CAPS – 4/5
The Motley Fool CAPS isn't too special, just another avenue for publishing your articles on your personal blog there (plus you can leverage off the established brand). The main benefit is the large audience of people who’re into the stock market. It has various other interesting features, but is definitely a distant second to Seeking Alpha.

Hedgehogs.net 3/5
Hedgehogs is similar (slightly superior) in function to the other two, this one lets you publish a blog on their site but also offers high touch interactivity and social features. A must if you’re aiming for maximum distribution or if you have a particular emphasis on hedge funds.

iStockAnalyst 2/5
iStockAnalyst has the benefit of publishing just about anything that you submit, and a reasonably large relevant audience. But it lacks social aspects that make sites like Seeking Alpha stick out. Use this and the other two for maximum readership and linkages, but not so much for credibility…

Daily Markets 2/5
Daily Markets will tend to automatically publish your articles if you prove to have worthy and relevant content. It’s similar to iStockAnalyst but I would say a little better in terms of quality and layout, but it lacks on the social features front.

GuruFocus 1/5
GuruFocus is another stock pickers website that allows you to submit articles for publication. Nothing special, but worthy of a look, and has a few social features, but not a huge following.

Now that you’ve got some ideas on where to publish your articles, and you’ve probably published a few, it’s time to look at how to tell people about your articles. This is the promotion side of things – same deal with the descriptions. This side of things is just another aspect to the whole promotion and distribution mix – and it pays to have your goals in mind.

As mentioned in Part I business exchange is virtually a must. Join up and you can add your own articles to relevant topics. It pays to also occasionally add other articles so you attract a reasonable following on there.

Simple: create a Facebook fan page and share links to your articles. Or if you have a personal Facebook account simply share the links. I’d recommend going for the fan page as it works better for attracting/building a fan base.

Tip’d – 3/5
Tip'd is an article sharing service, kind of like Digg, but with a business focus. You can add articles under “economy” topics, etc. Well worth adding to your article promotion habits.

bizSugar – 2/5
Similar function to Tip’d, bizSugar is nothing too different, has a specific focus on small business - which is interesting... Just sign up and submit your articles with a witty summary.

fwisp – 2/5
fwisp is similar to bizSugar and Tip’d but has a slightly smaller user base, worthy of a look.

Investor Links has an add your article feature, but it’s a little difficult to navigate – it’s ok to miss this one off your list, but include it for maximum punch if that’s your goal.

Others – 1/5
Then there’s a whole host of others from yahoo buzz, to digg, to reddit, in fact it’s worth integrating an “add this” button to your blog or website so that people can easily add your articles to those more generic social media sites. It’s probably a waste of time to go submitting your article to every service under the sun, but worth being aware of what’s out there.

Summary
So there you have it, a whole range of options for publishing and promoting your work on the Internet. To give you the bottom line; you need to have a blog, you need to be on Seeking Alpha, and you really should connect to business exchange and twitter. All the rest are nice to have and will augment the main ones, but will suit various strategies and goals. So get out there and start publishing and promoting.

Article Source: http://econgrapher.site1.net.nz/socialmedia-pt2.html

Disclosure: "No positions"
Feb 11 12:39 PM | Link | Comment!
• ##### Social Media For Economists: Part 1 - Connecting To Intelligent Sources
This article is part of a 2-part series on social media, specifically targeted towards economists, strategists, and more broadly, investors. The objective is to educate people with an interest in economics and financial markets on how to best use Social Media websites.

The first article will explain how to tap into social media websites to obtain unique information and insights, and connect to individuals whose work you respect. The second article goes more into detail on how to publish your own work, as well as promoting both your work and your own personal brand.

What is Social Media?
Social Media, or interchangeably, social networking, is any web-based facility where people can connect and share information. Popular examples of this are Facebook, LinkedIn, Twitter, etc. In fact there’s a good chance you’ve come to this article through, or are reading it on a social media website.

Over the past decade social media and social networking capability on the Internet has developed from simple “Web 1.0” e.g. bulletin boards, email, to more advanced and innovative “Web 2.0” e.g. more advanced networking options “following”, “adding friends”, easy sharing of articles and websites, mobile access, etc. The sector continues to evolve and change, so it’s important that you stay up to date and experiment – not all social media websites are useful, and even the useful ones take a bit to make the most of them.

Why Should You Use it?
Social media is an effective way of tapping into smart minds and resources. In some ways it can be considered a valuable alternative to traditional media websites e.g. you can either scan all the headlines yourself or you can follow someone who picks up important news. It is also a source of news, with people publishing their own thoughts and analysis on their own blogs or blogging sites like Seeking Alpha.

In short, you can circumvent the traditional – arguably limiting – way of knowing, and tap into a new way of knowing. Blogs are an excellent example in that collectively they represent a diverse range of people with real expertise sharing their own thoughts and analysis – usually you wouldn’t gain access to this unless the author was considered important enough to be quoted in the media (or have the right friends) or if you were a client of theirs.

But of course, since there’s generally no editor or quality controller, you have to take the good with the bad. There are bloggers who are worth paying attention to, and then there are some that you can probably skip. It’s also true that you have to take their analysis with a grain of salt – check their references, and be mindful of unjustified assertions. You can also gain some confidence in their work by judging from the number of people that follow them. But now I’m jumping the gun…

Important Sites, and How to Make the Most of Them
Now that you’ve had a brief introduction to social media, it’s time to learn by doing. Below I’ve listed some of the key social media websites of relevance to economists and strategists, along with a paragraph on how to make the most of each site. I will link to my own profile on each site as an example – so sorry if this seems like a self-promotion drive, but my objective is first and foremost to educate you on social media. I’ve also given them a score out of 5, depending on my judgment of their usefulness for helping economists and investors tap into useful news and analysis.

Seeking Alpha – 5/5
Seeking Alpha is the first on the list, and is an absolute must to get involved in. There are wide ranges of people that publish articles on Seeking Alpha, on both broader macro-economic themes, as well as individual stocks. There are a number of high quality contributors on the site and it pays to join up and start following a few of your favorite authors. They send you daily updates of new articles, and this can be a good way of automatically tapping into that site.

Motley Fool CAPS – 3/5
This Motley Fool site is more stock focused, and allows you to participate in a stock picking game of sorts. The main value of this site is the blogs section. Here you can tap into a similar crowd as Seeking Alpha, albeit more of a stock-picking site with no quality control. The only vote of quality is posts that have a large amount of ‘recommendations’. It’s worth keeping on the radar, but definitely a distant second compared to Seeking Alpha.

Hedgehogs.net – 4/5
Hedgehogs is a new up and coming site, which has the potential to compete with Seeking Alpha, yet offering something quite unique and different. It is targeted more towards the hedge fund community and has a focus on creating apps and sharing programming/software. Definitely a must if you’ve got anything to do with hedgefunds, but also worth paying attention to generally – they aim to become something of a next Bloomberg. On the site you can connect with other like-minded individuals and follow their blogs and discussions.

If you’re not on Twitter yet then you should get on it right away. It’s definitely not the be-all and end-all but it is a useful way of connecting to streams of news and updates. Basically what you ought to do is find people worth listening to on there and start following them – they will post updates e.g. a one liner on what happened, and/or a link to the story. But it’s up to you to keep visiting the site and checking what people are doing/saying.

StockTwits – 4/5
Stock Twits is basically a Twitter app – or in other words Twitter for investors. This distinction puts it at a rank above Twitter on the relevancy scale. However it still has usability issues. Best to give it a try and see how it works for you.

Business Exchange is somewhat similar to Twitter, but I’d go out on a limb here and say that for economists/investors this is a much better, more useful tool. Basically people join up and share articles, then they and others can comment on (“react” to) articles. You can follow and be followed by people. It’s worth connecting to this site and simply monitoring the content channels (you can pick relevant topics to keep an eye on) for interesting news. You can also follow a few people that have added articles you like in hopes that they continue to do so.

Facebook is of marginal use, the main benefit is to connect to fan pages of companies, authors, bloggers on there that you’re interested in and you’ll be kept current with what they’re up to. It’s worthy of mention, but is probably more of a fun/social thing than an information source per se.

More of a professional networking tool than a research tool. Worth looking into from a professional standpoint, you can also link in to career groups and share links with people in your network.

Econolog – 4/5
Not a social media site per se but highly relevant – basically a real time directory of economics blogs. Definitely a must to monitor… indeed blogs should have their own category in this article, but this is probably a good proxy for all blogs in general. Another way to find and connect to blogs is generally via most of the previous sites e.g. Seeking Alpha, Twitter – most people link to their main blog.

Of course I should mention the new Google Buzz. So far it seems like an interesting tool; a mix of Facebook, Twitter, Google Reader, Gmail … all mashed into something that’s somewhat uncomfortably slotted into your trusty Gmail account. So far it seems to have promise, but I’ll need to keep using it for a bit before I can make an informed comment. But with most things in this area, the general advice line is to give it a try.

Summary
There are other sites out there that will offer similar functionality to those listed in this article; the main thing is to keep trying new things. Social media offers a new way of knowing, and if used wisely will offer you an often entertaining and fulfilling way of accessing insights and analysis while also interacting with your peers.

Article Source: http://econgrapher.site1.net.nz/socialmedia-pt1.html

Disclosure: "No positions"
Feb 11 4:14 AM | Link | Comment!

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