Guest Article - More About Blood-Ex

This weekend features a first for Kennedy's Corridor. We have arranged to have Alex Zelvin write a featured article. Alex has a blog of his own called ThoroughMetrics and is the founder of ThoroughMetrics (http://www.freewebs.com/breedinganalysis), which does statistical analysis and research for the thoroughbred racing industry. I'm honoured and excited to have him as my guest.

-----------------------------------------------------------------------------------------
More About Blood-Ex

As a thoroughbred racing fanatic and a fairly serious student of financial markets, I’m looking forward to the upcoming launch of Blood-Ex, the first thoroughbred bloodstock trading exchange. I believe that this is an exciting development that is likely to bring new owners into the game, and a potential profit opportunity for those who trade wisely. Blood-Ex is set to launch in the UK sometime this summer, with expansion to the US and other countries later this year.

For those who haven’t read about Blood-Ex yet, here’s a brief summary of how it works. Owners may put up for sale shares of horses in training that meet certain criteria. Each share represents 1/150th of 1% of the horse. These shares do not carry any obligation for ongoing expenses, and do not entitle the holder to any share of the horse’s earnings on the track. When the owner puts shares up for sale, they will be required to put the horse up for auction at some point in the future, to determine the value of each share. Orders to buy and sell shares will be made on Blood-Ex just like limit orders on a stock exchange. Buying won’t cost anything, but all sales will have a 5% commission.

Along with horse racing, and financial markets, I’m also an obsessive fantasy baseball player. Last year, I participated (and finished 8th out of 4,000+ people) in a new game that used a stock market type trading mechanism. Because it was the first year the game had been run, nobody knew exactly how the ‘market’ would function. Two lessons that I learned there, that I think apply to Blood-Ex as well:

There’s no way to know exactly what will happen once trading starts, or what strategies will be successful.
Whatever happens, you’ll be in a better position to succeed if you’ve already given some thought to the possibilities prior to the start of trading.

I think the second point is especially true, because ‘immature’ or new markets are often the least efficient, and provide the greatest opportunities for profit. Once Blood-Ex has thousands of participants, including some with large sums of money available to them, the inefficiencies in the market will begin to disappear, and opportunities will be harder to find.

In the meantime, here are four things to think about as you prepare for the start of trading:

1. The 5% commission on sales is huge. It’s very possible that it will turn all short term trading strategies into losers. It should be less of an issue for those who plan to buy and hold shares. Also, it appears that you will not have to pay the commission when horses you own shares of are sold at auction. So if you’re holding shares of a valuable horse, it will generally be better to simply hang on to them until they’re sold than to sell them on Blood-Ex.

2. Most male horses end up their careers worthless as bloodstock. While trading in fillies and mares may have some resemblance to stock trading, with relatively modest price gains and losses, trading in colts and stallions is going to look like options trading…a few big winners, and a lot of 100% losses. Because of that, any long-term ‘portfolio’ of shares should hold very small positions in colts, and diversify across many of them. Because of the lower volatility, it should be ok to hold fewer, more concentrated positions of shares in fillies and mares.

3. Pay attention to the spread, or the difference between the best bid (offer to buy) and the best ask (offer to sell). Generally speaking, the spread will act as an additional transaction cost. If you want to make sure you get shares in a horse, you’ll have to make your offer to buy at a price equal to the best ask. But if you try to sell those same shares, even if the price hasn’t moved at all, you’ll need to sell them at the level of the best bid to guarantee yourself a buyer. So you’ll lose money on the round trip. That said, if you’re patient there are situations where the spread can work to your advantage. Instead of placing your buy orders at the best ask, place them just above the best bid, and wait to see if someone is willing to lower the asking price of their shares. And instead of placing your sell orders at the best bid, place them just below the best ask, and wait to see if an eager buyer is willing to pay what you’re asking. Until trading starts we really have no idea how wide the spreads on Blood-Ex are going to be. Most likely they’re going to be relatively narrow on well known horses which are actively traded. But for more obscure horses, spreads could be 15-20% of more. If that’s the case, there’s an opportunity to overcome the impact of the commission simply by placing buy orders on horses at a price just above the best big and placing sell orders on those you acquire just below the best ask. However, if you try this, you should probably not leave your orders open during the horse’s races, when the price (and perceived value) of the horse is likely to move sharply in one direction or the other.

4. Pay attention to how responsive the market is to news. Initially there may be relatively few participants, and prices may react slowly to news. This is likely to be most true for horses that aren’t stars. If you follow the news closely, you may be one of the first to learn of an injury or a particularly fast workout. Once the market has more participants, it’s likely that price moves in reaction to news will be so fast that there isn’t an opportunity for most to profit from it. One aspect of this that should be particularly interesting to see is how prices will move during the running of a race. As far as I can tell, trading in horses will not be frozen during their races, although it wouldn’t surprise me if this is done to avoid wild price swings.

Alex Zelvin