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Computerized Investing > September 22, 2012

Intrade

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by CI Staff

Intrade is a fascinating website for those who like to speculate. Specifically, Intrade is a prediction market that allows individuals to bet on the outcome of hundreds of real-world events. To make a prediction, users buy and sell shares on the outcome of real-world events defined as a Yes/No proposition, such as, will Barack Obama be re-elected in 2012?

Buying shares indicates you believe the event will happen, while selling (i.e., short selling) indicates you believe the event will not happen. If the event happens, each share is valued at $10.00. If the event does not happen, shares are valued at $0.00. Shares are bought or sold at a price between $0.00 and $10.00, depending on the probability of the event happening as determined by the market. Moreover, there are no transaction fees or commission charges on Intrade. Rather, users are charged a $4.99 monthly fee, which allows them to make an unlimited number of predictions. If there is no money in your account, the fee is not charged.

At the time of writing this article, the probability of Obama being re-elected stood at 67.4% because the share price was $6.74. If you believe Obama will be re-elected, your upside is $3.26 per share. If you believe Romney will be elected, you could short sell the probability of Obama winning or buy the probability of Romney winning. Interestingly, Intrade is not an entirely efficient market. However, arbitrageurs may still find it difficult to take advantage of the inefficiency since there is not a faster or computerized trading option. If you short sell the probability of Obama winning, your upside potential is $6.74 per share, while your downside potential is $3.26 per share. Unlike in the stock market, the potential loss from short selling on Intrade is defined.

In order to guarantee payment, Intrade freezes the maximum amount individuals can lose whenever they make a prediction. If you cannot cover your maximum potential loss, you cannot buy or sell the shares. Although users can buy and sell shares early (i.e., before the event occurs or expires), which means they will not experience the full gain or loss, they still must be able to cover the maximum loss when taking a position.

Perhaps best of all, rational investors can also use Intrade to gauge sentiment on a variety of events. For instance, most investors agree that the market, in general, will rally if Romney wins the election and it will plummet if Obama wins. Intrade says there is only a 32.6% probability of Romney winning. Therefore, a rational investor may not find it an optimal time to purchase shares in defense companies, for instance, which are among the companies that will benefit most from a Romney victory. Unfortunately, Intrade is not an efficient market and has much less volume than the market, which means it may not be a reliable predictor, especially because predictions can be quite volatile.

Intrade

www.intrade.com

Price: $4.99 per month for unlimited number of predictions


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