Foretelling the Future: Online Prediction Markets

They decided to bet that McCain would make a comeback, and of course they were right. Today the McCain shares they bought for around 5 cents are worth 19 times that. The value of Bethan and Jonathan's Intrade account has increased by about $250,000, mostly from betting on McCain.

On Intrade.com traders can buy shares of Hillary Clinton and Barack Obama. Their price indicates whether or not buyers believe the candidate has a good chance of winning the Democratic nomination.

(ABC News Photo Illustration)

Now Intrade is more than just a place where people win or lose money making bets. It turns out that the share prices on Intrade can be accurate predictors of the future. Intrade attracts a large and diverse crowd of bettors, and because each participant puts their money on the line, they may be more likely to make careful decisions.

As a result of the collective intelligence of more than 77,000 bettors on Intrade, the prices on the site may be a good way to predict the outcome of current events -- more accurate than some polls and pundits.

In 2004, the market odds on Intrade predicted the presidential vote of every state but Alaska. In 2006, the odds correctly indicated the outcome of every Senate race.

The Wisdom of Crowds

James Surowiecki explained why prediction markets are so accurate in his book "The Wisdom of Crowds."

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We have heard bad things about crowds. They're uncontrollable and prone to mob psychology. But under certain conditions, Surowiecki argued, crowds can be wise.

"Even though no one person in the crowd knows everything," Surowiecki said, "if the crowd is big enough and it's diverse enough, you just have access to so much more knowledge than you do if you ask one expert or even a really small team of experts."

You can see this on "Who Wants to Be a Millionaire?" When a contestant is stumped, they can call an expert, usually a smart friend, or they can poll the audience.

"The experts, they do pretty well. They get the answers right about two-thirds of the time," Surowiecki said. "But the audience gets the answer right 91 percent of the time."

The wisdom of crowds isn't limited to game show audiences. The Navy learned about this principle 40 years ago when the nuclear attack submarine Scorpion became lost somewhere in the North Atlantic. The search went on fruitlessly until a Navy man named John Craven assembled a large group of people, from deckhands to captains, and asked them many different questions that would help predict the location of the lost submarine. He didn't just ask them what they thought, he asked to them to bet on it.