Edward Thorp: The Genius Who Beat the Casinos And The Stock Market

Was Edward Thorp just a skilled mathematician, or did he revolutionize how we gamble and trade financial assets? Discover the man who not only conquered blackjack with his card counting system, but also shook Wall Street with his quantitative and systematic investing techniques. Thorp is best known for his Blackjack book, but he has one of the best track records in the hedge fund business.

This article looks into Thorp’s strategies and his impact on casinos, trading floors, and beyond.

Let’s first start with the key takeaways:

Key Takeaways

• Edward Thorp is acknowledged for his applications of probability theory to gambling and finance, revolutionizing blackjack with his card counting system and influencing the investment world with his quantitative hedge fund techniques.
• His book ‘Beat the Dealer’ detailed his card counting system, leading to widespread changes in casino practices due to its effectiveness, and such strategies are still a part of blackjack today.
• Thorp’s transition from academia to finance showcases his versatile application of mathematical principles, resulting in the creation of the first market-neutral hedge fund and the pioneering of convertible bond arbitrage, profoundly shaping the hedge fund industry.
• Ed Thorp has one of the best track records in the hedge fund business.

The Genius of Edward Thorp: American Mathematics Professor

Edward, an American mathematics professor born in Chicago on August 14, 1932, gained fame for his revolutionary use of probability theory.

From early childhood, Thorp showed a profound interest in science by conducting experiments and embracing amateur radio operations when he was only twelve years old. This curiosity laid the groundwork for his future as an influential mathematician and game theorist whose work would alter practices across various fields — from gambling at Las Vegas blackjack tables to strategizing on Wall Street.

Thorp’s contributions were especially notable in finance and gambling, where he applied game theory innovatively. His approaches significantly changed how risk is evaluated, and strategic decisions are made within these sectors.

Early Life and Education

Growing up in Southern California, Thorp developed an ardent interest in science from a young age. He was especially inspired by his involvement in the 1949 Science Talent Search. Initially beginning his higher education at UC Berkeley, he later moved to UCLA where he specialized in physics for his undergraduate degree.

Driven by an unquenchable desire to delve into mathematics, Thorp went on to undertake a Ph.D. at UCLA within that field. His dissertation titled ‘Compact Linear Operators in Normed Spaces’ served as a foundation for what would become significant input not only within mathematical circles but also across various other sectors influenced by his work.

Academic Career

Thor’s scholarly path spanned from MIT to New Mexico State University and eventually led him to the halls of the University of California, Irvine. His academic pursuits extended beyond mere statistics into functional analysis. He deeply enriched probability and statistics with his extensive work on statistical metric spaces’ generalized topologies as well as discerning digit distributions in numerical tables.

This educational odyssey sheds light on Thorp’s intellectual prowess, which would ultimately revolutionize the gambling and finance sectors. It underscores how his mathematical accomplishments have made a resounding influence within mathematics and across various fields far beyond it.

The Art of Card Counting: Blackjack and Beat the Dealer

Thorp revolutionized the gambling arena by applying his mathematical prowess to blackjack, forever altering the game. He ingeniously developed a card counting system that harnessed the computational capabilities of an IBM 704 to run extensive simulations on blackjack hands—a cutting-edge application of computer technology in gambling at that time.

The core idea behind Thorp’s method was elegantly straightforward: by tracking the balance between high and low cards remaining in the deck, players could detect moments when they held a statistical edge over the dealer.

In his influential work ‘Beat the Dealer,’ Thorp disseminated this potent technique widely, teaching audiences how they could effectively apply card counting strategies to consistently defeat casinos’ edge in blackjack. This begs inquiry into how Thorp conceived such an ingenious tactic against one of history’s most enduring card games.

Origins of Card Counting

Blackjack captivated Thorp due to its reliance on luck. Compelled by this challenge, he conducted an analysis of the game’s different components, including how the odds were affected when tens were taken out and the issues that arose from casinos’ employment of ‘short shoes’ to enhance their advantage.

Thorp faced doubt from individuals who thought blackjack was a random game that couldn’t be reliably conquered. His methodical strategy in dissecting the nuances of blackjack led to a transformative shift in gambling tactics.

Impact on Casinos and Players

Thorp’s introduction of card-counting strategies revolutionized the gambling scene, causing significant monetary setbacks for many casinos. In response, these establishments altered their practices by increasing the number of decks in blackjack and deploying shuffling machines to weaken the impact of card counting.

‘Beat the Dealer,’ once published, brought widespread attention to card counting methods and indelibly influenced blackjack gameplay. It inspired a wave of professional gamblers who embraced Thorp’s techniques, fundamentally changing the dynamics within the gambling industry.

The First Wearable Computer: A Collaboration with Claude Shannon

Thorp continued to push the envelope beyond blackjack, joining forces with Claude Shannon—renowned as the ‘Father of Information Theory’—to develop what would be recognized as history’s first wearable computer. Its purpose was bold: to forecast the results in roulette games. Ingeniously compact, this device could fit inside a cigarette packet and be hidden comfortably in a shoe while relaying signals directly to an earpiece.

In practice during roulette sessions, Thorp gave off an impression of casually jotting down notes when actually he received insightful betting prompts through his earpiece from Shannon who analyzed the motion trajectory of the ball. This raises curiosity about how such an unconventional collaboration was initially formed between them.

Meeting Claude Shannon

During his time as a professor of mathematics at MIT, Thorp encountered Claude Shannon. Their mutual fascination with gambling games such as roulette and blackjack sparked a partnership to devise a method for forecasting the results of roulette spins.

The synergy between these two thinkers gave rise to the first wearable computer in history, demonstrating not only their remarkable collaborative spirit but also the profound implications that applied mathematical strategies can have on practical challenges like gambling.

Creating the Wearable Computer

Thorp’s work while pursuing his physics degree inspired the conception of a device capable of forecasting roulette results. In collaboration, they integrated Thorp’s insights on gambling methods with Shannon’s proficiency in transmitting information to create this revolutionary technology.

This pioneering wearable computer reached its ultimate form as a small apparatus that could be hidden inside footwear, enabling subtle transmission of wagering data. Their joint venture resulted in the inaugural application of such a wearable computer within the setting of a Las Vegas casino for gambling purposes.

From the Casino Floor to Wall Street: Hedge Fund History

Thorp turned his attention from casinos to the equally competitive world of Wall Street. His questioning nature, which he directed toward gambling industry assertions, also made him skeptical about widely held notions within financial markets.

Utilizing analytical abilities sharpened through gambling experiences, Thorp formulated investment strategies for financial markets. The expertise he acquired in probability and managing funds during his time at the casino became crucially relevant to his pursuits in finance.

Yet what was Thorp’s approach in transferring his fundamental arithmetic skills and capacity to validate theories into the finance sector mathematically?

Applying Probability Theory to Finance

Leveraging his expertise in mathematics, physics, and finance, Thorp crafted statistical models that based on both his blackjack tactics and financial investments. His use of probability theory within finance allowed him to identify irregularities in pricing across markets by employing a methodical approach like of his gambling methods.

Thorp’s founding of the initial market-neutral hedge fund in 1969 marked a significant advancement in convertible arbitrage techniques. He underscored the importance of balancing risk with potential returns when making investment decisions. He championed rigorous backtesting for strategies while maintaining a critical eye toward schemes that appeared overly promising—exemplified by instances like Madoff’s fraudulent activities. Thorp thought that Madoff was a fraud a decade before he was caught.

Hedge Fund Success and Influence

Thorp is celebrated for pioneering the use of quantitative methods within financial markets, setting a foundation for contemporary mathematical finance. His establishment and management of Princeton Newport Partners hedge fund have showcased his lasting impact on hedge fund strategy through consistently high returns.

Thorp’s practical application of these quantitative strategies in managing his hedge funds – initially with Princeton/Newport Partners and subsequently Ridgeline Partners – demonstrated the potency of applying mathematics to finance. The impressive 20 percent annualized return he realized from personal investments over nearly thirty years is a testament to his financial techniques’ efficacy.

Influential trading practices such as Thorp’s ‘most-up-most-down’ (MUD) system revolutionized transactions in stock market environments by reshaping how many investors execute their buy and sell decisions.

Thorp exemplified adaptability by evolving his own methodologies—for instance, transitioning from market-neutral to sector-neutral arbitrage—thereby motivating industry professionals to pursue investment tactics that are not static but instead adaptive.

Real Estate Cautionary Tale: Lessons Learned from Thorp’s Ventures

Thorp expanded his activities from blackjack and Wall Street into the real estate sector, highlighting the importance of a long-term perspective and cautioning against speculative investment tactics that, while potentially profitable in the short term, contain concealed dangers. Much like his strategies elsewhere, his approach to investing in property is marked by measurable and systematic techniques grounded in a disciplined and reasoned management of risk.

What, then, did Thorp take away as specific lessons from delving into real estate investments?

Thorp’s Real Estate Investments

Thorp shared an anecdote about a friend who passed on the opportunity to sell his home for $3 million because he was holding out for $3.25 million, only to end up waiting ten years. By clinging to the hope of a slightly higher selling price, his friend forfeited the chance to significantly grow that money in the stock market—potentially by double or triple—over those ten years, which might have resulted in gains exceeding a million dollars.

A Life of Science and Risk: Ed Thorp’s Legacy

Edward Thorp, through his mastery of probability theory, fundamentally altered the perception of risk and likelihood in both gambling and financial industries. His notable achievements include:

• The pivotal role he played in developing the Black-Scholes option pricing model which not only made a lasting impact on economic theories but also laid groundwork for subsequent advancements.
• He transformed investing practices with his pioneering application of quantitative techniques within hedge funds to navigate financial markets.
• Demonstrating the practical success of these methods, Thorp’s own hedge fund flourished, exemplifying how skills honed in gambling can be effectively transferred to manage high-stakes risks in stock market investments—a strategy that has since been emulated widely.

Yet one might wonder: In what ways did Edward’s profound understanding of mathematics propel his substantial contributions to scientific knowledge?

Contributions to Mathematics and Science

Thorp’s contributions to mathematics have altered the perception of probability and statistics. His exploration into probability theory has notably pushed the boundaries of knowledge, especially with his pioneering efforts in card counting in gambling.

Inspiring Future Innovators

Thorp’s achievements have served subsequent generations of forward-thinkers. By harnessing the power of science and mathematics, he illustrated that one could strategically search for and exploit advantages within seemingly unpredictable events.

Who is Edward Thorp?

Edward Oakley Thorp was born on August 14, 1932, in Chicago, Illinois. Renowned for his innovative use of probability theory and contributions to game theory, Thorp has made significant waves in both the finance and gambling sectors. By demonstrating through mathematical evidence that card counting can reduce and overcome blackjack’s house edge successfully. He authored “Beat the Dealer,” a definitive book on this technique.

Key achievements attributed to Edward Thorp are:

• Holding positions as a mathematics professor at prestigious institutions like MIT and University of California, Irvine.
• Partnering with Claude Shannon to devise the initial wearable computer tailored for gambling ventures.
• Transforming financial markets by using statistics and probability into lucrative hedge fund management strategies applied within the stock market.

Thorp was also one among those who doubted Bernie Madoff’s suspiciously consistent investment earnings early on—a skepticism vindicated by Madoff’s eventual exposure in 2008 as operating a Ponzi scheme.

Thorp has also written three books, including not only “Beat the Dealer,” but also works about investing titled “Beat The Market,” along with his autobiography dubbed “A Man For All Markets.”

What is Edward Thorp famous for?

Edward Thorp is famous for beating the casino in blackjack, his success in the hedge fund business, and his mathematical contributions. We can also add that he is famous for looking 20 years younger than his age.

Edward Thorp has left an indelible mark on probability theory with groundbreaking achievements such as:

• Exploiting minuscule correlations for consistent financial benefits
• Mathematically proving that the house advantage in blackjack can be nullified through card counting, a strategy he thoroughly explains in his book “Beat the Dealer”
• Translating his theoretical expertise into practical success by identifying mispricing in the stock market and skillfully running hedge funds like Princeton/Newport Partners and Ridgeline Partners
• Demonstrating early skepticism about Bernie Madoff’s seemingly exceptional investment returns which were later exposed as fraudulent activities in 2008

Thorp’s contributions have fortified his esteemed reputation in both gambling circles and financial markets.

His pioneering work also includes authoring “Beat the Dealer,” which became a New York Times bestseller and is recognized as the foundational text for card counting strategies at blackjack. He is celebrated as the progenitor of wearable computing technology due to creating what is acknowledged to be the first-ever wearable computer back in 1961.

How did Edward Thorp beat the stock market?

Edward Thorp beat the stock market by applying statics and backtests to find solid trading strategies. Thorp outperformed the stock market by leveraging arbitrage opportunities, which was a cutting-edge strategy when he introduced it in his 1967 publication.

He developed an equation similar to the Black-Scholes model, though it didn’t incorporate the risk-free interest rate due to then-current market configurations. Thorp identified and capitalized on mispriced options by using this formula to predict options pricing accurately, turning these discrepancies into gains.

He implemented the Kelly Criterion which is a strategic approach to optimal capital allocation. Thorp’s insights in “Beat the Market” were revolutionary and continue to be highly regarded for their enduring applicability within financial markets.

What strategies did Edward Thorp use in trading?

Edward Thorp’s trading strategies were mainly based on statistical arbitrage, which involves taking advantage of price discrepancies between different markets or securities. He used mathematical models, incorporating various market factors like volatility and volume, to identify profitable trades. His approach involved buying undervalued securities and selling overvalued ones, informed by his analysis of historical data and future price movement predictions.

The strategy had a quantitative model at its core, utilizing advanced mathematical algorithms to analyze market data and signal profitable trades. The key features of Thorp’s strategy were:

• Utilizing a quantitative model with advanced mathematical algorithms
• Incorporating risk management techniques to minimize losses during market fluctuations
• Adapting the strategy to changing market conditions and capitalizing on new opportunities

Can Edward Thorp’s methods still be applied today?

Edward Thorp’s methods can still be applied today. In gambling, especially blackjack, card counting is a robust tactic for assessing whether the next hand favors the player or dealer. Current card counting techniques employ a scoring system to monitor high and low value cards’ running count, which helps gamblers modulate their wagers and playing tactics.

Meanwhile, casinos are deploying surveillance systems and advanced technology, including software that scrutinizes betting patterns and deviations from standard playing methods to spot card counters. Despite such safeguards by casinos making it more difficult to carry out effectively, many still engage in card counting as it can be lucratively rewarding.

In finance, Thorp’s concepts between investment risk and reward remain relevant today. They underscore the critical balance of neither over-betting nor underutilizing capital resources at one’s disposal. His methodology, scouring for inefficiencies within markets to capitalize on mispriced opportunities, is still valid today.

What book did Edward Thorp write about gambling?

Edward Thorp authored the groundbreaking work “Beat The Dealer,” a book that transformed blackjack by demonstrating mathematical proof of how card counting can counteract the house advantage. He wrote “The Mathematics of Gambling,” offering an in-depth examination of several gambling games, encompassing:

• baccarat
• backgammon
• blackjack
• roulette
• wheel of fortune

Thorp’s contributions to literature on gambling have not only revolutionized game strategy, but also ushered in a new era where analysis and mathematics underpin our approach to these games.

How did Edward Thorp apply probability to gambling?

Edward Thorp applied probability to gambling by studying the statistics of blackjack and then using a card counting system.

In Las Vegas, Edward Thorp demonstrated that the casino’s house advantage in blackjack could be nullified by employing card counting strategies based on probability theory. By simulating blackjack outcomes with an IBM 704 computer, he developed a game theory framework to increase his winning probabilities. Significantly, this edge became more pronounced towards the conclusion of a deck not reshuffled after each deal.

Undertaking practical experiments in Reno, Lake Tahoe, and Las Vegas casinos supported Thorp’s theoretical assertions as he engaged in actual games of blackjack utilizing his card-counting techniques. His ability to win significant sums confirmed his academic theories were correct. Card counting could indeed tip the balance of success away from the house toward the gambler.

Did Edward Thorp invent any card counting techniques?

Yes, Edward Thorp invented card-counting techniques. Edward Thorp developed the premier, mathematically verified system for card counting in blackjack and presented it to the public in his 1962 work “Beat the Dealer”.

By harnessing conditional probability, which considers that cards played are not reshuffled until a deck cycle completes, Thorp’s method revolutionized how players approach the game.

The essence of Thorp’s revelation was recognizing that a surplus of tens and aces remaining in play enhanced player odds while an abundance of lower-value cards tilted favor towards the dealer. His straightforward card counting strategy monitors this balance between high and low-value cards within the shoe, thus empowering gamblers to modify their betting strategies to gain leverage over the house.

How did Edward Thorp’s academic background help him?

Thorp’s solid academic background in physics and mathematics equipped him to pioneer influential techniques in gambling and finance.

His expertise enabled him to program an IBM 704 computer using Fortran, simulating blackjack probabilities—an endeavor rooted firmly in his mathematical prowess and coding skills.

Thorp’s education provided the tools necessary for understanding and implementing the Kelly criterion, a strategy outlined by John L. Kelly Jr.’s paper from 1956, to optimize betting sizes effectively in gambling contexts like blackjack and stock market ventures.

The proficiency Thorp developed through his study of mathematics allowed him to:

• Detect statistical irregularities within the securities market that he could leverage
• Excel as a manager of a hedge fund
• Accumulate personal investment returns at an impressive annualized rate of return—averaging over 28 years—of around 20 percent annually.

What was Edward Thorp’s profession before trading?

Edward Thorp’s profession before trading was academic research and teaching. He served as a professor at the Massachusetts Institute of Technology (MIT) between 1959 and 1961. He continued to impart knowledge in mathematics at New Mexico State University until 1965.

Thorp transitioned to becoming one of the inaugural faculty members at the University of California, Irvine, in 1965, where he instructed students in mathematics and finance from 1977 onward. During this period, he leveraged his mathematical acumen within gambling and finance, establishing an enduring impact that resonates within these sectors even today.

How has Edward Thorp influenced modern trading strategies?

Edward Thorp has influenced modern trading strategies by using strict systematic and backtested trading strategies. Edward Thorp’s contribution to finance, particularly in advancing quantitative analysis techniques, established him as a pioneering quant and set the foundation for contemporary hedge fund strategies. He was instrumental in:

• Creating the first market-neutral hedge fund.
• Introducing quantitative methodologies into asset management.
• Developing approaches to take advantage of inefficiencies within markets.

Thorp’s approach has transformed hedge funds’ operations by integrating methodical and mathematical practices into investment decisions through his company Princeton Newport Partners. His development of these quantitative market strategies cemented his legacy in financial management.

What role did mathematics play in Edward Thorp’s success?

Mathematics was an essential part of Edward Thorp’s success. Thorp’s achievements hinged on his profound grasp of mathematics, particularly in probability theory and the use of linear operators.

These disciplines were essential to his pioneering work in blackjack and his devising new strategies for use in financial markets. Thorp researched blackjack probabilities utilizing an IBM 704 computer and constructed his game theory based on the Kelly criterion, a formula designed to ascertain the ideal bet size across multiple wagers.

When he transferred his mathematical knowledge to the stock market, he uncovered several pricing irregularities, which he then exploited to reap considerable gains. Thorp partnered with Claude Shannon to create a wearable computing device that helped them gain an upper hand at roulette through strategic bets placed on clusters of adjacent numbers within the wheel’s layout.

Did Edward Thorp create any financial instruments?

No, Edward Thorp did not create any financial instruments. Edward Thorp is celebrated for his trailblazing contributions in quantitative finance, yet it’s not documented that he invented a unique financial instrument.

His expertise is largely centered on investment strategies and methodologies. He penned numerous pieces about option pricing and statistical arbitrage strategies, emphasizing strategy development rather than creating individual instruments.

Thorp’s influence in quantitatively driven finance has significantly impacted the evolution of financial markets. His work devising sophisticated financial strategies endures as a cornerstone that shapes contemporary trading techniques.

How did Edward Thorp’s strategies impact casinos?

Edward Thorp’s strategies impacted casinos because they were forced to clamp down on card counters not to lose money.

The ingenious card-counting tactics introduced by Edward Thorp caused a significant disruption within the gambling industry, inflicting notable monetary setbacks on many casino operators. In response to these challenges, casinos were compelled to revise their blackjack games—modifying game rules and increasing deck quantities—to undermine the benefits gleaned from card counting techniques.

The release of Thorp’s groundbreaking “Beat the Dealer” book sparked an unprecedented surge in blackjack’s popularity across America, as it became a favorite among casino-goers. Such dominance forced establishments into aggressive and subtle confrontations with counters, and casinos hired skilled gamblers specifically to challenge them, reportedly employing methods like administering drugs.

Casinos clearly recognized the profound economic implications of Thorp’s strategies for beating dealers at their own game through his advanced form of card counting. Consequently, they invested heavily in new practices and sophisticated technologies designed expressly to diminish any edge skilled players might obtain using such approaches.

What challenges did Edward Thorp face in his career?

Edward Thorp faced many challenges in his career; for example, he was almost forced to shut down his hedge fund after an investigation under the Racketeer Influenced and Corrupt Organizations Act put a strain on its finances. Even though he was acquitted of all charges, the costs associated with defending against these allegations compelled the liquidation of Newport Partners.

Thorp’s card counting strategies led to several personal challenges.

• He was expelled from countless casinos.
• Casino-employed professional gamblers targeted him.
• In one instance at a Vegas casino, Thorp suspected that he had been drugged.
• There were signs that someone tampered with his car resulting in what could have been a deadly crash.
• To gain entry into gambling establishments as his fame grew due to the success of his blackjack system—and as those casinos began implementing measures to thwart him—he resorted to using disguises.

How did Edward Thorp prove his theories?

Edward Thorp proved his theories by utilizing an IBM 704 computer and rigorously testing his hypotheses about blackjack through computer simulations.

These formed the foundation of his game theory approach to winning at the card game. To verify these strategies, he engaged in practical experiments within casinos across Reno, Lake Tahoe, and Las Vegas. By implementing his methods while playing blackjack in real settings, Thorp amassed considerable sums of money, thereby confirming the efficacy of his theoretical framework.

The empirical data gathered from Thorp’s forays into gaming establishments aligned with what had originally been mere thought experiments. They corroborated that through card counting techniques, players could indeed gain a significant advantage against casino operations. His findings supported this aspect of game theory as applied to blackjack play in actual casino environments.

What awards has Edward Thorp received?

Edward Thorp has received awards by being a member of Blackjack Hall of Fame in addition to several mathematical awards.

Beyond blackjack, Ed has made significant strides in broader gaming strategies by creating the “Thorp count,” which serves to determine winning probabilities in specific endgame scenarios within backgammon.

Thorp’s notable impact across mathematics, finance, and gambling earned him the prestigious Edward O. Thorp Memorial Prize—a lifetime achievement accolade that honors his extensive contributions to these disciplines.

How did Edward Thorp’s work affect hedge funds?

Edward Thorp’s work affected hedge funds because it showed how a systematic and backtested approach could be very profitable.

He introduced quantitative analysis into finance and, by launching the inaugural market-neutral hedge fund, set up a foundation for contemporary hedge fund tactics. These advancements were critical in integrating systematic methods into asset management.

Thorp’s approach to influencing hedge funds’ operations focused on leveraging discrepancies within financial markets. His enterprise, Princeton Newport Partners, was at the forefront of applying these sophisticated quant strategies, which have since become engrained in the fabric of financial investment practices.

What is Edward Thorp’s advice for novice traders?

Edward Thorp advises novice traders to use a mathematically inclined and strategic approach to investment. If novice traders have no time for research, they should buy stocks and invest for the long run.

Thorp counsels these newcomers to:

• Be on the lookout for “fat pitches,” exceptional chances that are more likely in times of crisis, which offer lopsided risk/reward balances necessitating swift action for advantage.
• Stressing the significance of possessing a competitive edge while engaging in trading activities.
• Highlighting how critical it is to identify market inefficiencies as a key element leading towards successful trading.

Thorp imparts wisdom upon new traders by recommending they:

• Acquire reliable information promptly
• Adopt disciplined and logical investment strategies, favoring systematic assessment over emotional responses
• Concentrate their investing efforts within areas where they have considerable expertise—aptly referred to as one’s “circle of competence”—to utilize personal knowledge and evaluative skills with an aim at outperforming the market
• Approach leveraging judiciously. Always prepare for unfavorable scenarios and mitigate leverage when there’s an inability to withstand potential losses.

How has Edward Thorp contributed to financial education?

Edward has contributed to financial education via teaching and the impactful knowledge shared in his books. His writing, especially within “A Man for All Markets,” sheds light on effective investment tactics and a comprehensive grasp of financial markets. This text stands as an essential resource for investors at all levels by highlighting critical principles such as probabilistic thinking and quantitative evaluation.

Beating The Odds – The First Quant (A Man For All Markets)

Ed Thorp wrote A Man For All Markets, a financial bestseller and an excellent read for any aspiring systematic and algorithmic trader.

Many consider Edward Thorp “the first quant,” at least one of the first to successfully use quantitative models for risk-taking. He became famous when he wrote the book Beat The Dealer, in which he documented a rational way of betting to beat the casinos in blackjack.

Edward Thorp later studied the financial markets, and in 1967, he published Beat The Market – a book about arbitrage. Profiting from arbitrage is very difficult today, but it was ingenious when this was written. Edward Thorp’s trading strategies are 100% quantified and mechanical.

Ed Thorp has one of the best investing track records – purely by quantified strategies

Outside the inner circles of hedge funds and academic researchers, Thorp is not well known despite a stellar track record for his hedge fund, Princeton Newport Partners (PNP). From 1969 until 1988, PNP never had a losing year, and he decided to close because of a rogue employee (for reasons that had nothing to do with Thorp).

PNP compounded 19.1% from 1969 to 1988, almost more than double that of the S&P 500, with significantly less drawdowns. After the unpleasant encounter in 1988, Thorp decided to manage his own money and stop serving investors except for friends and family. Managing outside money was not worth the time and hassle.

In 2017, Thorp published A Man For All Markets: Beating The Odds, From Las Vegas To Wall Street, a personal odyssey in science, gambling, and financial markets. In the introduction, Thorp writes that he aims to show that a simple approach beats most investors and experts. Unfortunately, he doesn’t reveal much of his findings from his arbitrage trading.

Thorp argues you can do well with simple strategies, but he recommends long-term passive investing for most investors.

A Man For All Markets: Beating The Odds, From Las Vegas To Wall Street

The book’s first part is mainly about Thorp’s youth, where he developed skills by reading and experimenting (trial and error). This applies to trading and investing: be curious, never take a fact for a fact, and do your own research by trial and error:

Chance can be thought of as the card you are dealt in life. Choice is how you play them. I chose to investigate blackjack. As a result, chance offered me a new set of unexpected opportunities.

The second part is how he developed his betting systems in blackjack, roulette, and baccarat. This resulted in the book Beat The Dealer and sparked his interest in the greatest casino of them all: the stock market.

The third part of the book is the longest one: his involvement in the financial industry – which he mostly despises because of frequent fraud and low ethics:

There is another kind of risk on Wall Street from which computers and formulas can’t protect you. That’s the danger of being swindled or defrauded……..the point being that hedge fund investors don’t have much protection and that the most important single thing to check before investing is the honesty, ethics, and character of the operators.

Unfortunately, he doesn’t detail any of his strategies, except that they all involved some kind of arbitrage.

The last part, the fourth, is more philosophical, where he explains basic investment principles and general advice on how you should go about life and investing. One interesting part was that he already in 1991 concluded that Bernie Madoff was a fraud.

We recommend the book if you are interested in gambling, probabilities, and finance.

However, don’t expect any great details or special knowledge. As Nassim Taleb writes in the foreword: Thorp’s contributions are how you can succeed by keeping things simple.

Thorp ends by explaining what should be your guide in life: not wealth and fame, but how you spend your time on the things you enjoy. Nassim Taleb writes in the introduction:

True success is exiting some rat race to modulate ones’s activities for peace of mind.

Quotes, takeaways, and lessons from A Man For All Markets: Beating The Odds, From Las Vegas To Wall Street:

Below are some lessons and takeaways from the book.

From Nassim Nicholas Taleb’s foreword:

Thorp’s contributions are vastly more momentous than he reveals. Why? Because of their simplicity. Their sheer simplicity.

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The context is as follows. Ed Thorp is the first modern mathematician who successfully used quantitative methods for risk-taking – and most certainly the first mathematician who met financial success doing it.

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When you reincarnate as a practitioner, you want the mountain to give birth to the simplest possible strategy, and one that has the smallest number of side effects, and the minimum possible hidden complications.

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Now money management – something central for those who learn from being exposed to their own profits and losses. Having an edge and surviving are two different things. The first requires the second. As Warren Buffet said: in order to succeed you must first survive. You need to avoid even the smallest risk of ruin in trading. At all costs.

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True success is exiting some rat race to modulate one’s activities for peace of mind.

From Thorp’s book:

A trait that showed up about this time was my tendency not to accept anything I was told until I had checked it for myself. ….From the beginning, I loved learning through experimentation and exploration how my world worked.

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For the rest of my life I would meet Depression-era survivors who retained a compulsive, often irrational, frugality and an economically inefficient tendency to hoard.

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Understanding and dealing correctly with the trade-off between risk and return is fundamental, but poorly understood, challenge faced by all gamblers and investors.

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Chance can be thought of as the card you are dealt in life. Choice is how you play them. I chose to investigate blackjack. As a result, chance offered me a new set of unexpected opportunities.

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This plan, of betting only at a level in which I was emotionally comfortable and not advancing until I was ready, enabled me to play my system with calm and disciplined accuracy. This lesson from the blackjack tables would prove invaluable throughout my investment lifetime as the stakes grew ever larger.

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Many were good and some would go on to make their living from blackjack, but for the majority the effort and persistence required to practice card counting, the restraint and discipline needed, to say nothing of the temperament, were obstacles to success.

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Betting too much, even when though each individual bet is in your favor, can be ruinous…..On the other hand, playing safe and betting too little means you leave money on the table. The psychological makeup to succeed at investing also has similarities to that for gambling. Great investors are often good at both.

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Once again, just as with casino games, I was surprised and encouraged by how little was known by so many. And just as blackjack, my first investment was a loss that contributed to my learning.

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I had no idea when to sell. I decided to hang on until the stock returned to my original purchase price, so as not to take a loss. This is exactly what gamblers do when they are losing and insist on playing until they get even.

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As I would learn, most stock-picking stories, advice, and recommendations are completely worthless.

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I learned from this that even though I was right in my economic analysis I hadn’t properly evaluated the risk of too much leverage.

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There is another kind of risk on Wall Street from which computers and formulas can’t protect you. That’s the danger of being swindled or defrauded.

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Portfolio insurance was designed to protect investors from large market declines. Ironically, the cure became the cause. (the crash of 1987)

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As Princeton Newport Partners closed I reflected on the proposition that what matters in life is how you spend your time.

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Heller said he had something the rich man could never have….”The knowledge that I’ve got enough.”

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Then again, people tend to make the error of seeing patterns or explanations when there aren’t any, as we’ve seen from the history of gambling systems, the plethora of worthless pattern-based methods, and much of story-based investing.

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The consensus of industry studies of hedge fund returns to investors seems to be that, considering the level of risk, hedge funds on average once gave their investors extra return, but this has faded as the industry expanded. Later analyses say average results are worse than portrayed.

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It’s difficult to get an edge picking stocks. Hedge funds are little businesses just like companies that trade on the exchanges. Should one be any better at picking hedge funds than we are at picking stocks?

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You need to know enough to make a convincing, reasoned case for why your proposed investment is better than standard passive investments such as stock or bond index funds. Using this test, it is likely you will rarely find investments that qualify as superior to the indexes.

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In fact, hedge funds frequently start out small and build spectacular records, later turning ordinary as they grow.

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…the point being that hedge fund investors don’t have much protection and that the most important single thing to check before investing is the honesty, ethics, and character of the operators.

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I apply this to the trade-offs among health, wealth, and time. You can trade time and health to accumulate more wealth. Why health? You may be stressed, lose sleep, have a poor diet, or skip exercise. If you are like me and want better health, you can invest time and money on medical care, diagnostic and preventive measures, and exercise and fitness.

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In my experience, superior stock-picking ability is rare, which means almost everyone should make the switch. (to passive investing)

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The threat to a buy-and-hold program is the investor himself. Following his stocks and listening to stories and advice about them can lead to trading actively, producing on average the inferior results about which I’ve warned. Buying an index avoids this trap.

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The EMH is a theory that can never be logically proven. All you can argue is that it is a good or not-so-good description of reality. However, it can be disproven merely by providing examples where it fails, and the more numerous and substantive the examples, the more poorly it describes reality.

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Be a disciplined rational investor. Follow logic and analysis rather than sales pitches, whims, or emotion. Assume you may have an edge only when you can make a rational affirmative case that withstands your attempts to tear it down. Don’t gamble unless you are highly confident you have an edge.

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Be aware that information flows down a “food chain”, with those who get it first “eating” and those who get it late being eaten.

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Thorp on dividend investing:

Curiously, he thinks he can only spend income, in the form of dividends and interest, and he views capital appreciation as something less real. I tried, and failed, to convince him that a higher total return (after tax) means more money to spend and more money to keep, no matter how it divides between realized income and unrealized capital gains or losses. To own a stock like Berkshire Hathaway, which has never paid a dividend, and therefore produces no “income”, would be unthinkable for him. This investor’s costly preference for realized income rather than total return (economic income) is common.

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In recent years, especially in a crisis, world markets, reflecting the increasing globalization of information through technology, have tended to move much more in tandem with the US market, limiting the amount by which diversification overseas reduces risk.

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Because you can’t get out in time when trouble is coming, the excess returns you expect from illiquid investments may be offset by the economic impact of unforeseen future events.

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Assume that the worst imaginable outcome will occur and ask whether you can tolerate it. If the answer is no, then reduce your borrowing.

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On betting size:

William Poundstone points out that for a favorable bet that pays odds of $A for a bet of $1, the optimal Kelly bet is the percent of your capital equal to your edge, divided by the odds, A. In blackjack, the typical favorable edge was usually between 1 and 5 percent and the odds, or payoff per dollar bet, averaged a little more than 1. So, following the criterion when the card count was good, I bet a percentage of my bankroll that was a little less than my percent advantage. Kelly’s criterion is not limited to two-value payoffs but applies generally to any gambling or investing situation in which the probabilities are known or can be estimated.

As I pointed out in the Wilmott magazine, Warren Buffett’s thinking is consistent with the Kelly Criterion.

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On how likely are you to go broke as retired or FIRE:

What if you want the payouts to continue “forever” as you might for an endowment? Computer simulations showed me that with the best long-term investments, such as stocks and commercial real estate, annual future spending should be limited to the inflation-adjusted level of 2 percent of the original gift. This surprisingly conservative figure assumes that future investment results will be similar in risk and return to US historical experience. In that case, the chance that the endowment is never exhausted turns out to be 96 percent……The 2 percent spending limit is so low because, if the fund is sharply reduced in its early years by a severe market decline, a higher spending requirement might wipe out.

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Again, an investment in corporate bonds more than doubled on average over this period and long-term US government bonds almost did so, showing that diversification into asset classes other than equities, though possibly sacrificing long-term return, can preserve wealth in bad times.

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Making a profit is trickier. Like a Ponzi scheme, it’s not easy to tell when it will end. If you bet against it too early you can be ruined in the short run even though you are right in the long run. As Keynes said, the market can remain irrational longer than you can remain solvent.

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Education builds software for your brain. When you’re born, think of yourself as a computer with a basic operating system and not much else…..Even more valuable, I learned at an early age to teach myself. This paid off later on because there weren’t any courses in how to beat blackjack, build a computer roulette, or launch a market-neutral hedge fund.

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Most of what I’ve learned from gambling also is true for investing. People mostly don’t understand risk, reward, and uncertainty.

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Simplistically, there are two types of rich, those who use government to tilt the playing field in their favor and those who don’t….Another theme for dealing with public policy issues is to simplify rules, regulations, and laws. Get the government out of the business of micromanaging.

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As Benjamin Franklin famously said: “Time is the stuff life is made of,” and how you spend it makes all the difference.

Edward Thorp’s trading strategies have one of the best track records there is, yet he is still relatively unknown. The book doesn’t go into details about his trading strategies but it is nonetheless a great read!

Summary

Edward Thorp’s contributions have significantly changed both the gambling and financial sectors. By using probability theory, statistics, and backtesting, he reshaped our understanding of risk and systematic trading from Las Vegas blackjack to Wall Street trading floors.

Frequently Asked Questions

Where does Edward Thorp live?

Residing in Newport Beach, California, Edward Thorp was a trailblazer in applying quantitative investment strategies within the financial markets.

Who invented card counting?

A mathematician by the name of Edward O. Thorp is recognized for devising the technique of card counting, and he introduced this method to the masses with his 1962 publication titled “Beat the Dealer.”

How did Edward Thorp make his money?

Utilizing his expertise in gambling, Edward Thorp generated significant wealth by applying these skills to the financial markets. He accomplished remarkable gains through his hedge fund, capitalizing on mispriced opportunities within the securities markets.

What is Edward Thorp best known for?

Edward Edwards is an Edwardian politician. Thorp stands out for his innovative use of probability theory in the realms of gambling and finance, achievements that include devising a card counting strategy for blackjack and effectively managing a hedge fund.

How did Edward Thorp’s academic background contribute to his success?

Edward Thorp’s strong academic roots in mathematics and physics were crucial to his groundbreaking contributions in the realms of gambling and finance. Leveraging his command of mathematics along with his computer programming skills, he was able to create advanced models for assessing blackjack probabilities.

What is Edward Thorp’s investing track record with Princeton Newport Partners (PNP)?

Edward Thorp’s investing track record with Princeton Newport Partners (PNP) is outstanding – one of the best in the industry. PNP, managed by Thorp, had a remarkable track record, compounding at 19.1% from 1969 to 1988. It outperformed the S&P 500, experiencing significantly fewer drawdowns. Thorp closed PNP in 1988 due to a rogue employee but continued managing his own money afterward.

What is Edward Thorp’s stance on investing strategies, and what does he recommend for most investors?

Thorp suggests that simple, long-term passive investing is often the most effective strategy for most investors. He emphasizes the importance of a disciplined, rational approach and avoiding the pitfalls of active trading.

What are some key lessons and takeaways from Edward Thorp’s book, “A Man For All Markets”?

Thorp’s book covers some key lessons about his journey in science, gambling, and financial markets. Key lessons include the value of curiosity, learning through experimentation, the importance of a disciplined approach in both gambling and investing, and the need to evaluate the risk of leverage.