In November 2024, prediction markets called the U.S. presidential election more accurately than most polls. Polymarket showed Trump at 60%+ probability while pollsters had it as a toss-up.
Prediction markets got it right. Polls got it wrong.
This wasn't luck. Prediction markets aggregate information differently than polls or pundits—and increasingly, traditional traders are paying attention.
This guide explains what prediction markets are, how they work, and how they relate to the stock market you already know.
What Are Prediction Markets?
Prediction markets are exchanges where you trade contracts based on future events.
Instead of buying shares of a company, you buy contracts that pay out based on whether something happens:
- Will the Fed cut rates in March?
- Will inflation be above 3% next month?
- Will Company X beat earnings?
- Will it snow in NYC on Christmas?
Each contract trades between $0 and $1 (or 0¢ and 100¢). The price represents the market's implied probability of the event occurring.
How Pricing Works
| Contract Price | Implied Probability |
|---|---|
| $0.75 | 75% chance of "Yes" |
| $0.50 | 50/50 (coin flip) |
| $0.20 | 20% chance of "Yes" |
If you buy a "Yes" contract at $0.30 and the event happens, you receive $1.00—a profit of $0.70 (233% return).
If the event doesn't happen, you lose your $0.30.
Prediction market prices are essentially crowd-sourced probabilities. When a contract trades at $0.65, the market collectively believes there's a 65% chance the event occurs.
The Major Platforms
Kalshi (U.S. Regulated)
What it is: CFTC-regulated prediction market for U.S. traders
Key features:
- Legally available to U.S. residents
- Event contracts on economics, weather, finance, entertainment
- Recently approved for political event contracts
- Dollar-denominated, real money
- Regulated like a futures exchange
Popular contracts:
- Fed rate decisions
- Inflation readings (CPI)
- GDP growth
- Government shutdowns
- Box office results
Why it matters: Kalshi is the first fully regulated prediction market in the U.S. It's legal, compliant, and treats contracts as derivatives under CFTC oversight.
Polymarket (Crypto-Based)
What it is: Decentralized prediction market using cryptocurrency
Key features:
- Crypto-native (USDC stablecoin)
- Larger liquidity for political/geopolitical events
- Not available to U.S. residents (officially)
- No KYC for smaller amounts
- Blockchain-based settlement
Popular contracts:
- Elections and political events
- Geopolitical outcomes
- Crypto-specific events
- Celebrity/entertainment
Why it matters: Polymarket often has the deepest liquidity for major events. Its 2024 election markets became a real-time probability tracker followed by mainstream media.
PredictIt (Academic)
What it is: CFTC no-action letter market run by Victoria University
Key features:
- U.S. accessible (with limits)
- $850 maximum position per contract
- Political events focus
- Lower liquidity than Kalshi/Polymarket
- Currently winding down some operations
Prediction Markets vs Traditional Markets
Here's how prediction markets compare to the instruments you already trade:
Structure Comparison
| Feature | Stocks | Options | Futures | Prediction Markets |
|---|---|---|---|---|
| Underlying | Company ownership | Right to buy/sell stock | Commodity/index delivery | Event outcome |
| Price range | $0 to ∞ | $0 to ∞ | -∞ to ∞ | $0 to $1 |
| Expiration | None | Fixed date | Fixed date | Event resolution |
| Max loss | 100% of investment | Premium paid (buyer) | Unlimited (some) | 100% of investment |
| Max gain | Unlimited | Unlimited (calls) | Unlimited | Contract payout - cost |
| Settlement | Continuous | Exercise/expiration | Delivery/cash | Binary (Yes/No) |
Key Differences
1. Binary Outcomes
Stocks can go anywhere. Prediction markets resolve to exactly $0 or $1.
- Stock: AAPL could be $150, $200, or $180 next month
- Prediction: "AAPL beats earnings" is either Yes ($1) or No ($0)
2. Time-Bounded
Every prediction contract has a resolution date. There's no "hold forever" option.
3. Information Aggregation
Prediction markets are designed to surface collective knowledge. Stock prices reflect value; prediction prices reflect probability.
4. No Dividends or Ownership
You don't own anything. You have a claim on a binary payout based on an event.
What Prediction Markets Do Better
1. Pricing Specific Events
Want to know the probability of a Fed rate cut? A stock tells you nothing directly. An option gives you implied vol. A prediction market gives you an actual probability.
| Question | Stock Market Answer | Prediction Market Answer |
|---|---|---|
| Will the Fed cut in March? | Unclear | 73% probability |
| Will CPI be above 3%? | Infer from bonds | 42% probability |
| Will Trump win? | Infer from sectors | 58% probability |
2. Information Discovery
Prediction markets often lead traditional markets because they directly price the event. During the 2024 election:
- Polymarket showed Trump probability rising days before polls caught up
- Traders used this signal to position in stocks, sectors, and currencies
3. Hedging Specific Risks
If your portfolio is exposed to a specific event, prediction markets let you hedge directly:
- Long energy stocks? Buy "No" on "Democrats win White House" as a hedge
- Short duration bonds? Buy "Yes" on "Fed cuts rates" as a hedge
- Exposed to regulatory risk? Hedge with relevant policy contracts
4. No Company-Specific Risk
Prediction markets on macro events (Fed, inflation, elections) have no earnings surprises, no CEO scandals, no accounting fraud. The event either happens or it doesn't.
What Traditional Markets Do Better
1. Liquidity
The S&P 500 trades billions of dollars daily. Even the largest prediction markets are tiny by comparison.
| Market | Daily Volume |
|---|---|
| S&P 500 (SPY) | $30B+ |
| Apple (AAPL) | $10B+ |
| Polymarket (large event) | $10-50M |
| Kalshi (typical contract) | $100K-1M |
2. Continuous Exposure
Stocks give you ongoing exposure to a company's performance. Prediction markets expire—you need to continuously roll positions.
3. Leverage and Derivatives
Options on stocks let you structure complex payoffs. Prediction markets are simpler (binary) but less flexible.
4. Regulatory Clarity
Stocks are regulated, insured (SIPC), and have established legal protections. Prediction markets are newer, and crypto-based ones carry platform risk.
How Traders Use Prediction Markets
Signal Extraction
The most common use: treat prediction market prices as probability estimates to inform stock trades.
Example: Fed Decision
- Kalshi shows 80% probability of rate cut
- If you think the true probability is 60%, stocks may be overpriced for the cut
- Position accordingly in rate-sensitive sectors
Example: Election
- Polymarket shows 65% Republican win probability
- Historically, certain sectors outperform under each party
- Use the probability to size sector tilts
Event Hedging
Directly hedge event risk instead of using correlated assets.
Without prediction markets:
- Long oil stocks, worried about regulation
- Hedge by shorting XLE or buying puts
- Imprecise—XLE moves for many reasons
With prediction markets:
- Long oil stocks, worried about regulation
- Buy "Yes" on "Carbon tax passes"
- Direct hedge on the specific risk
Arbitrage (Advanced)
When prediction markets disagree with options markets, arbitrage opportunities exist:
- Kalshi: "S&P 500 up >5% by year end" at 40¢
- Options market: Implied probability from call spreads suggests 50%
- Trade the discrepancy
Arbitrage between prediction and traditional markets is complex. Liquidity, transaction costs, and timing differences make execution difficult.
Prediction Market Strategies
Strategy 1: Fade the Extreme
When contracts trade near 0¢ or 100¢, small probability shifts create large returns.
- Contract at 95¢ implies 95% probability
- If true probability is 85%, the contract is overpriced
- Selling at 95¢ to collect 5¢ if "No" (5.3% return) vs. losing 95¢ if "Yes"
Risk/reward can be asymmetric at extremes.
Strategy 2: Trade Volatility Events
Before major announcements (Fed, CPI, earnings), prediction contracts move. Trade the movement, not just the outcome.
- Buy contract at 50¢ before announcement
- Announcement shifts probability to 70%
- Sell at 70¢ for 40% profit—before final resolution
Strategy 3: Cross-Market Signals
Use prediction markets as leading indicators for stock positions.
- Prediction market shifts on Fed policy → Position in rate-sensitive stocks
- Election probability changes → Adjust sector exposure
- Regulatory contract moves → Hedge or add to affected industries
Risks and Limitations
Liquidity Risk
Most prediction contracts are thinly traded. Large positions move prices. Exiting can be difficult.
Platform Risk
- Kalshi: Regulated, but still a young exchange
- Polymarket: Crypto-native, smart contract risk, regulatory uncertainty
- PredictIt: Winding down operations
Resolution Risk
Who decides if an event "happened"? Edge cases create disputes:
- What counts as a "recession"?
- When exactly did the event occur?
- How are ties or partial outcomes handled?
Regulatory Risk
Prediction markets exist in a gray area in many jurisdictions. Rules can change. Platforms can be shut down or restricted.
Manipulation Risk
With lower liquidity, motivated actors can temporarily move prices. Large political donors have incentive to manipulate election markets for narrative purposes.
The Information Theory Behind Prediction Markets
Why do prediction markets work? They harness three powerful mechanisms:
1. Skin in the Game
Unlike polls or pundit predictions, prediction market participants risk real money. This filters out noise and incentivizes accuracy.
2. Aggregation of Distributed Knowledge
No single person knows everything, but markets aggregate dispersed information:
- Insiders with partial knowledge
- Analysts with models
- Locals with on-the-ground insight
3. Continuous Updating
Prices update in real-time as new information arrives. Polls are snapshots; markets are streams.
The Efficient Market Hypothesis applies here too: If a prediction contract is mispriced, traders profit by correcting it. This self-correcting mechanism pushes prices toward true probabilities.
Prediction Markets and Stock Correlations
Certain prediction outcomes have clear stock market implications:
| Prediction Event | Stock Market Impact |
|---|---|
| Fed rate cut | Growth stocks ↑, Banks ↓ |
| Higher inflation | TIPS ↑, Growth ↓, Commodities ↑ |
| Republican president | Energy ↑, Defense ↑, Clean energy ↓ |
| Democrat president | Clean energy ↑, Healthcare ↓ |
| China tariffs | Importers ↓, Domestic manufacturers ↑ |
| Recession declared | Defensives ↑, Cyclicals ↓ |
Monitoring prediction markets gives you a real-time probability dashboard for these scenarios.
Getting Started
For Information Only
You don't need to trade prediction markets to use them:
- Kalshi - Free to browse, see real-time probabilities
- Polymarket - Public dashboards, no account needed to view
- Metaculus - Forecasting platform (not real money, but useful signals)
For Trading
Kalshi (U.S.):
- Sign up with ID verification
- Deposit USD
- Trade like any exchange
Polymarket (Non-U.S.):
- Connect crypto wallet
- Deposit USDC
- Trade on-chain
Position Sizing
Start small. Prediction markets are volatile around resolution. A 50¢ contract can go to 0¢ or 100¢ quickly.
Rule of thumb: Never bet more than you'd spend on an options trade with similar binary characteristics.
Key Takeaways
What prediction markets are:
- Exchanges for trading event outcomes
- Prices represent implied probabilities
- Binary payoffs: $0 or $1
How they differ from stocks:
- Time-bounded (expire at event resolution)
- Binary outcomes (not continuous price)
- No ownership, dividends, or company exposure
- Direct probability pricing
How traders use them:
- Signal extraction for stock positioning
- Direct event hedging
- Cross-market arbitrage (advanced)
- Information discovery
Platforms to know:
- Kalshi - Regulated U.S. exchange
- Polymarket - Crypto-based, largest liquidity for political events
- PredictIt - Academic market (limited)
The bottom line:
Prediction markets won't replace your stock portfolio. But they offer something traditional markets don't: direct, tradeable probabilities on specific events. Whether you trade them or just watch them, they're increasingly useful for understanding what the market really thinks is going to happen.