#93 Ed Thorp (A Man for All Markets)

**David Senra** (0:00)
Ed Thorp's memoir reads like a thriller, mixing wearable computers that would have made James Bond proud, shady characters, great scientists, and poisoning attempts. The book reveals a thorough, rigorous, methodical person in search of life, knowledge, financial security, and not least of all, fun. Thorp is a generous man, eager to share his discoveries with random strangers. Something you hope to find in scientists, but usually don't. Yet, he is humble. He might qualify as the only humble trader on planet Earth. So unless the reader can reinterpret what's between the lines, he or she won't notice that Thorp's contributions are vastly more momentous than he reveals. Why? Because of their simplicity, their sheer simplicity. For it is the straightforward character of his contributions and insights that made them both invisible in academia and useful for practitioners. My purpose here is not to explain or summarize the book. Thorp, not surprisingly, writes in a direct, clear, and engaging way.
I am here as a trader and a practitioner of mathematical finance to show its importance and put it in context for my community of real world scientist traders and risk takers in general. That 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. Thorp's method is as follows. He cuts to the chase in identifying a clear edge that is something that in the long run puts the odds in his favor. The edge has to be obvious and uncomplicated. For instance, calculating the momentum of a roulette wheel, which he did with the first wearable computer and with no less a co-conspirator than the great Claude Shannon, father of information theory. He estimated a typical edge of roughly 40% per bet. The computer turned a 5.3% disadvantage into a 40% edge.
But that part is easy, very easy. It is capturing the edge, converting it into dollars in the bank, restaurant meals, interesting cruises, and Christmas gifts to friends and family. That's the hard part. It is the dosage of your betting, not too little, not too much, that matters in the end.
A bit more about simplicity before we discuss dosing. For an academic judged by his colleagues, rather than the bank manager of his local branch or his tax accountant, a mountain giving birth to a mouse after huge labor is not a very good thing.
They prefer the mouse to give birth to a mountain, a very mountain. It is the perception of sophistication that matters to them. The more complicated, the better. The simple doesn't get you citations or some other metric to draw that brings the respect of the university administrators as they can understand that stuff, but not the substance of real work. The only academics who escaped the burden of complication for complication's sake are the great mathematicians and physicists. Ed was initially an academic, but he favored learning by doing with his skin in the game. When you reincarnate as a practitioner, you want the mountain to give birth to the simplest possible strategy and the one that has the smallest number of side effects, the minimum possible hidden complications.
Ed's genius is demonstrated in the way he came up with very simple rules in Blackjack. Instead of engaging in complicated and challenging card counting, something that requires one to be a savant, he crystallizes all of his sophisticated research into simple rules. Go to a Blackjack table, keep a tally, start with zero, add one for some strong cards, minus one for weak cards, and nothing for others.
It is mentally easy to just bet incrementally up and down, bet larger when the number is high and smaller when it is low, and such a strategy is immediately applicable by anyone with the ability to tie his shoes and find a casino on a map.
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 Buffett said, in order to succeed, you must first survive. You need to avoid ruin at all costs.
Academic finance did not get the point that avoiding ruin as a general principle makes your gambling and investment strategy extremely different from one that is proposed by the academic literature. Thorp and Kelly's ideas were rejected by economists in spite of their practical appeal. The famous patriarch of modern economics, Paul Samuelson, was supposedly on a vendetta against Thorp. Not a single one of the works of these economists will ultimately survive. Strategies that allow you to survive are not the same thing as the ability to impress colleagues.