How This Works

Active Markets excel in determining the value for a product or service.  If the price is higher than it's perceived value, no one buys and the price drops to a point where it will sell.

Stock exchanges find the price of stocks, and futures markets find the price of commodities. 

Prediction markets find the chance of an event happening, and the greater the chance the greater the value of the market.

Example Intrade Market

The U.S. will go into recession in 2008. If it does 1 share in this market = $10.  If it doesn't 1 share = $0

Traders buy and sell shares in this market.

Say it is trading at $4.50.

As $4.50 is 45% of $10 - this means that the market thinks the chance or odds of a recession is 45%

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In all markets "traders" have a clear financial incentive to make careful and accurate predictions.  In markets, you "put your money where your mouth is", you don't do this with opinion polls.

A trader buys at a time when he predicts the future price will be higher than what the present market indicates, and in so doing raises the consensus price.  Those who are correct make money from those who have been inaccurate in their predictions.  Markets can also induce those with private information¹ to use it, aggregating private information into a market can add potential value, so long as proper safeguards are observed.

If a commodities futures market can calculate the current consensus on an uncertain future commodity price, then a prediction market like Intrade can also measure the current consensus on the probability of a future event occurring.

If the market price for a U.S. $10.00 contract on "The U.S. Entering Recession in 2008" is U.S. $4.50, this would typically represent a consensus that there is a 45% chance of this happening.  Anyone could express their opinion on the subject by trading the market, or could just read the "market prices" to see the best current estimate.

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But aggregation and derivation of the consensus view is just part of what prediction markets do.  By aggregating the views and opinions of a crowd of interested participants, the derived consensus view is consistently smarter then any individual in the group.  Typically for a prediction market to work optimally there needs to be divergent opinions so that a non-biased equilibrium can be reached.

This counter-intuitive concept has been studied intensively by academics over the last 20 years.  In 1984 Roll² found that orange juice futures traders were more expert weather observers than weathermen.  In 2003³ Berg and Rietz found that a political prediction market was more accurate than polls while in 2002 Chen and Plott⁴ found that a small group of people selected specifically from diverse parts of a business beat the official forecasts for the business.

Therefore, the more participants a marketplace attracts, typically the more useful the market becomes.  It is the characteristics of aggregation, incentive and diversity that are behind the Intrade Prediction Market.

The Intrade marketplace, at the heart of the Intrade community, uses a market mechanism to answer questions on uncertain future events more accurately than alternatives such as peer-reviewed publications, polls or official reports.  It offers an easily understood, straight forward measure of the probability of any event occurring.

The Intrade platform offers a shortcut to the future, providing predictive information 24 hours a day.  The Intrade platform is aggregating new data all the time and in real-time in an efficient way on issues that matter.  If you want to discover what the consensus view is, on any issue, Intrade offers a diverse community of collective wisdom to tap into that issue.

The Intrade marketplace operates like a futures or options market, although one not linked to traditional commodities, but to a broader range of uncertain future events.  The wording of each prediction market will allow each to be judged true or false within a specific period.  Traders on Intrade will predict on a 0 to 100 price scale, where 0 = $0.00 in value (per share) and 100 equals $10.00 in value (per share) either in a real or a virtual currency.

The price of any share sold at a given time will then represent the market's view of the probability of the event outcome as represented by that current trade.  As there is always some probability that an event may occur, a trade can not happen at 0, but trades can happen at 0.1 of 0.1% probability ( U.S.$0.01 for a U.S.$10.00 contract).

The Intrade platform aggregates all trading based on a price and time priority basis and automatically presents the market consensus as of the last traded event, on hundreds of events at any given time.  It is this market consensus that is of such interest to the media and the public.

¹ - Intraday has seen numerous examples of apparent aggregation of private information; e.g. Two days before Saddam Hussein was captured, his Intraday market rallied when there was no public information available on the issue. This fact was reported in Time magazine.

² - Orange Juice and Weather, Richard Roll, The American Economic Review, Vol. 74, No. 5. (1984), pp. 861-880.

³ - Prediction markets as decision support systems, JeBerg, Ta Rietz, Information Systems Frontiers, Vol. 5, No. 1. (2003), pp. 79-93.

⁴ - Information Aggregation Mechanisms: Concept, Design and Implementation for a Sales Forecasting Problem, Kay-Yut Chen, Charles R Plott, (March 2002)