This article by the ScoreMetrics Lab gives you the basics on what compounding is and how sports traders can benefit from it in their systems.
The article is part of an ongoing series on educative sports trading topics and on treating the sports betting market as an investment opportunity:
”Investing is the act of allocating capital to assets with the goal and expectation of generating a profit. Good investing involves research, risk analysis, managing capital responsibly, and diversifying investments. Successful investors follow a long-term strategy or a system that matches their goals and tolerance for risk, and they follow that system non-emotionally.”
Making the most of your bankroll is a major factor in achieving success in the market, and compounding is a key concept that can skyrocket your returns. Let’s look at it in detail.
What exactly is compounding?
Let’s start with a short definition of compounding, by Investopedia:
”Compounding is the process in which an asset’s earnings, from either capital gains or interest, are reinvested to generate additional earnings over time. This growth, calculated using exponential functions, occurs because the investment will generate earnings from both its initial principal and the accumulated earnings from preceding periods. Compounding, therefore, differs from linear growth, where only the principal earns interest each period.”
In the stock market, compounding effects usually come in two forms.
First, letting your winners run and holding on to them leads to exponential gains over time. For example, let’s say that you initially invested $1000 in a stock and its value has gone up by 20% to $1200. You are holding on to the stock, and when its value goes up another 20% (to $1440), your gains are now more significant compared to the first 20% rise. Besides your original $1000 investment, the $200 gain in value is now also generating more gains for you.
The second compounding effect comes from reinvesting dividends to stocks instead of cashing them out. Again, you are keeping your gains in the portfolio and letting them grow by investing them back, without having to add more cash into your account.
How can compounding be applied to sports?
Good question! The answer is that it is pretty similar to the second compounding effect in the stock market that we discussed; the reinvestment of dividends.
In similar fashion to dividends, your winning trades in the sports betting market are obviously not automatically invested into anything. Instead, a winning trade gets paid to your account and your balance goes up.
To achieve compounding effects in sports trading, the unit size of your trades needs to go up over time once your bankroll is growing significantly thanks to a steady stream of winning trades. In other words, the single trades you’ll be executing need to get bigger over time – and you are now reinvesting your gains.
Increasing unit size needs to be done carefully – you don’t want to immediately start doubling the value of your trades after a few successful ones. That is a very efficient way of increasing the volatility of your sports trading system, and we don’t want that.
There are a couple of smart ways to increase unit size.
One simple way would be to think of a season in two halves and increase your unit size for the second half of the season, assuming that the first half has been a success and you have achieved major gains.
A more complex way would be to apply a percentage-based unit allocation related to the size of your bankroll, and to also weight the expected edge of the trade and size the unit based on these factors.
But since we are building systems that are based on long-term profitable patterns instead of handicapping games, this way of allocating unit size is not optimal because it relies heavily on allocating more capital to games where a handicapper has detected a significant edge for a single game.
Nevertheless, a research paper that is very illustrative on the effects of compounding, that used the type of methodology described above, was published for the 2020 MIT Sloan Sports Analytics Conference.
In the paper, Clay Graham, Candace Graham and Sola Talabi presented a complex MLB betting model that grew a $500k bankroll to $800k in less than two months, using a level unit allocation that did not change during that period of time.
Their calculations show that if they would have applied a percentage-based unit allocation system, and thus achieved compounding effects, the bankroll would have stood at more than $1.8 million at the end of the period.
That $1 million difference in such a short period of time shows exactly how powerful compounding effects can be in a sports trading portfolio.
Another way to reinvest your gains would, of course, be to diversify your sports trading system portfolio and start investing them in a new system, instead of increasing the unit size of your trades for existing systems.
Many ScoreMetrics sports trading systems utilize compounding effects for greater gains by increasing unit sizes throughout a season.
Sounds complicated? It really isn’t once you understand the basics of trading in the sports betting market. And there’s really no better way to gain that understanding than read our head trader John Todora’s new book – “Zero Correlation Investing – The Score Metrics Secret”. It’s currently on sale for a limited time, so go get yours now!
The ScoreMetrics Lab is the engine that runs the Sports Trading System operation, consisting of a team of researchers and writers who are constantly testing and retesting algorithms. They work hand in hand with our Head Trader and Creator of ScoreMetrics, John Todora to help find new breakthroughs and develop new systems.