Key Takeaways
- Prediction markets present a clearly defined question that results in a contract price that changes over time.
- The price is, in effect, a shorthand for how a group of traders views the odds of a particular event occurring.
- This sentiment signal can be a useful tool for analyzing the likelihood of an outcome.
- The size of the participant pool, the tendency of contract prices to behave in certain ways as the event in question draws nearer, and the amount of money in the market all impact the signal’s meaningfulness.
- Remember that market sentiment is not the same as certainty.
Prediction markets have skyrocketed in popularity and now offer an avenue to place wagers on just about any future event, from sports to politics to awards shows.
There are numerous reasons someone might buy a contract on a prediction market like Polymarket and Kalshi, from trying to capitalize on a highly informed opinion to just plain taking a flyer on a big game.
The upshot is that these platforms aggregate a broad array of opinions on defined questions into simple prices that range between $0.01 and $0.99 per contract. Those prices can and do fluctuate as new information comes out, revealing with some degree of specificity how the market—defined here as the number of participants on any given platform—views the likelihood of a given outcome.
That makes prediction markets useful for anyone looking for a measure of market sentiment. Whether they participate in event contract wagers or not, essentially every investor can benefit from the unique insight they provide on what a particular market expects to happen.
How Prediction Markets Reveal Sentiment
Prediction markets offer contracts based on specific questions: Who will win the Super Bowl? Who will be president in 2029? What will unemployment be on Jan. 1?
The contracts trade between $0.01 and $0.99, and settle at either $1.00 if the event takes place or at $0 if it does not. For instance, if a positive outcome contract for a particular event is trading at $0.70, the participants collectively believe there is a 70% likelihood of that outcome occurring.
In this way, contract prices become a straightforward way to measure sentiment. The more likely the outcome in the minds of participants, the higher the price. Say the “yes” contract on “Will unemployment be below 4% in December” trades at $0.70, but then four major companies announce massive layoffs. The price would likely slip to, say, $0.50, reflecting a downward shift in sentiment.
For Aaron Gaines, CFP, of Gaines Capital Management, a key benefit that prediction markets offer when it comes to sentiment is that “people aren’t just giving their opinion, they’re actually putting money behind what they believe.”
As a result, the contract price changes in real time, providing a simple illustration of how participants are reacting to things like interest rates, the economy, or any number of other real-world factors.
One thing to keep in mind, however, is that the sentiment reading is only as robust as the depth of the market. That means lots of participants putting up real money so that the viewpoints are diverse and no single trade is able to sway the market meaningfully.
Tip
Observers may be drawn to prediction markets as a gauge of overall market sentiment because they are straightforward to follow a single contract price figure that changes over time, rather than attempt to distill much more complicated and lengthy market analysis.
How Expectations Change
Prediction markets offer a view into market sentiment through price changes on specific contracts as new information, differing views, and various incentives land in the market.
A key aspect to remember for investors considering using prediction markets as a way to consider market sentiment is that the contract price reflects a particular moment of agreement and disagreement among participants in the contract process, not a settled fact.
A price of $0.70 on a yes contract “doesn’t mean there’s actually a 70% chance” that the event happens, Gaines said. It is simply “what the people buying and selling that contract believe it’s worth right now.”
And, of course, that price can and will change. If a candidate who was ahead in the polls gets caught in a scandal, that information will be internalized by the prediction market’s participants, and the “yes” contract on their winning would likely fall sharply in price.
It’s not uncommon for contract prices to approach $1 or $0 in binary payout scenarios as the event itself gets closer and the likelihood of a specific outcome moves closer to being known. Think about how the odds of a baseball team winning change as the game heads into the later innings.
Sentiment Is Not Certainty
Related to the tendency for expectations in prediction markets to change is the fact that broader market sentiment is dynamic and conditional, not a fixed measure of what will happen.
“Prediction markets aren’t crystal balls; they’re still made up of people, and people can be wrong,” Gaines said.
The idea is that a prediction market contract gives some insight into how some people are thinking about an event. It is not giving the definitive or even the authoritative view. How much weight you assign to the sentiment reading from an event contract comes down to some key metrics.
“Look at how many people are actually trading,” Gaines said. “If thousands of people are buying and selling, that price may tell you more than a market where only a small group of people are participating.”
For Gaines, that’s why prediction markets “are worth watching,” but you shouldn’t “build an investment strategy around them.”
Rather, the signal from a prediction market can be informative, even if it’s incomplete, distorted, or wrong.
“They can be another piece of information that helps you understand what people expect to happen,” Gaines said.
Warning
Many platforms continue to struggle with the impact of insider trading, another reason to exercise caution when evaluating the signal from any prediction market.
The Bottom Line
Prediction markets present a clearly defined question that results in a contract price that changes over time, offering a shorthand for how a group of traders views a particular event.
The contract price, which effectively corresponds to an outcome’s odds, can be a valuable signal of how the participants in this market view an event. At the same time, it’s important to keep in mind that there are complicating factors like the size of the participant pool, the tendency of contract prices to behave in certain ways as the event in question draws nearer, and even the fact that expectations can shift unpredictably.
Investors should remember that market sentiment is not the same as certainty and should consider prediction market data as one piece of their analysis on market sentiment.