Thorp’s early success in devising mathematical systems for beating the house, such as card counting, put him at an advantage in finance. He understood the need to either create an edge or walk away from the table. His efforts to find an edge in finance led to the development of pricing models for trading options, convertibles, and warrants before the published academic literature of Black–Scholes–Merton. He next trained his skills on solving problems in statistical arbitrage as well as finding arbitrage opportunities across the capital structure and through relative mispricing. For example, he tells an intriguing tale of how he was able to identify arbitrage opportunities in mutual savings bank conversions. Edward Oakley “Ed” Thorp is a mathematician, author, and hedge fund manager known for his groundbreaking work in probability theory and its applications.
Book Review – A Man for All Markets, By Ed Thorp
If you’re in finance and you haven’t read this book, well, you’re lacking. Compare that structure to Thorp’s now defunct Princeton-Newport Partners. Thorp arranged PNP such that the business was split into two geographically separate but equal offices.
- Rather than immediately starting another large fund, he stepped back for a while but still provided consulting services related to hedge fund selection.
- Towards the end of the book, Ed Thorp shares his insights on the financial markets and life in general and also recommends index funds to “normal” investors.
- Mr. Thorp concludes with a compelling account of the causes and aftermath of the financial crisis.
- Thorp’s book is chock- full of knotty lessons for investors, thinkers, and business people, but because Thorp is far less well covered than Munger, many of these ideas felt new and let me see them with fresh perspective.
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Edward O. Thorp rose up from nothing to become a professor at MIT, invented card counting and proceeded to beat the dealers of Las Vegas at blackjack, roulette and baccarat. Having brushed shoulders with casino mobsters and survived, he shared his secrets with the world, launching a gambling renaissance. His next stop was Wall Street, where he used statistical techniques to identify and exploit pricing anomalies in the securities markets, ushering in a stock market revolution and becoming one of the first of the great quantitative investors. In a remarkable career, Thorp attracted the attention of the legendary Warren Buffett, detected the Bernie Madoff scheme, invented the world’s first wearable computer and amassed a significant personal fortune. Thorp’s early focus on the nuances of blackjack card counting may not be of great interest to money managers, but he provides enough details on his research process and trade testing to keep readers engaged.
“Life is like reading a novel or running a marathon. It’s not so much about reaching a goal but rather about the journey itself and the experiences along the way.” “Markets are basic to modern economics, and trading is a fundamental activity.” These traits are rare enough when separate, but in those few in whom they converge achieve in one lifetime what ordinary genius would take several. Interestingly these four men knew and worked with each other at formative points in their careers.
What challenges did Thorp face in his gambling career as described in A Man for All Markets?
- In such circumstances, he advocates holding Berkshire Hathaway and index funds.
- Interestingly, he started studying physics but then switched to math because he could get his phd faster.
- The East Coast office handled all the business administration and trading execution work that Thorp found tedious.
- In a remarkable career, Thorp attracted the attention of the legendary Warren Buffett, detected the Bernie Madoff scheme, invented the world’s first wearable computer and amassed a significant personal fortune.
Merton and Scholes won the 1997 Noble price for the same discovery, but were unable to control themselves and use it safely within their circles of competence. Their hedge fund, Long Term Capital Management, blew up in 1998 and had to be bailed out by a government led consortium. At the time, Mr. Thorp was managing about $400,000 and the accounts were grossing about 25 percent a year, with 20 percent of profits payable to the general partner. Mr. Thorp’s $20,000 income from the partnership was equivalent to his salary as a professor and would only accelerate in the coming years as Princeton Newport Partners attracted additional assets and enjoyed steady success. Mr. Thorp retained his professorship for several years before finally dedicating all of his time toward investing in the early 1980s. I will admit, I haven’t written any book reviews in the last few months.
They have a strong mutual respect but different views on how to make money — that is, value investing versus relative value. The value of a warrant on a common stock is derived based the difference between the current stock price and the exercise price of the warrant as well as the amount of time before the warrant expires. A warrant will always have a positive value prior to expiration even if it cannot be exercised immediately at a profit because the possibility exists that it will become profitable to exercise prior to expiration. Mr. Thorp came up with the idea of developing mathematical models to determine whether warrants are mispriced relative to the price of the common stock.
Buffett x Feynman = Enjoyable Read
Seeing that I wasn’t quite following, and still reeling from the casual death threat, my dad handed me a dog-eared copy of Ed Thorp’s book Beat the Dealer, and said that that was how he had learned. The team of six, three men and three women, pretended not to know each other and made their way to the baccarat tables at the Dunes casino in Las Vegas. It was the spring of 1963 and Las Vegas was still controlled by shady characters connected to the mafia. It was the fourth night at the tables and the pit boss and casino management had taken note of the lead player’s wins and were not happy. However, on this night, the pit boss was smiling and offered the player coffee with cream and sugar “just the way you like it”. Shortly into the first round, the player sips his coffee and suddenly couldn’t think!
By purchasing the relatively underpriced security and shorting the overpriced security, one can exploit the market’s mistake without necessarily expressing an opinion on the merits of investing or shorting the underlying business. This is Thorp’s autobiography, made all the more colourful by his own narration. The race within financial market participants to be better and faster to gain an edge calculating fair values of a man for all markets instruments, ideally hedging off all risks becomes clear in the book. Mr. Thorp was already a very wealthy man as Princeton Newport liquidated. Rather than immediately starting another large fund, he stepped back for a while but still provided consulting services related to hedge fund selection. It was in this context that he encountered the Bernie Madoff fraud seventeen years before it ultimately collapsed.
From blackjack and roulette, where he helped develop the first wearable computer, Thorp moved on to the “big casino” — that is, Wall Street. Professional investors can learn much from Thorp’s application of his gambling-based methods of solving problems, measuring probabilities, and formulating choices to stock and options trading. Ed Thorp is not well known among money managers, but he is held in awe by traders as a polymath, successful card counter, mathematician, finance specialist, and hedge fund manager. Thorp is a model of someone who theorizes how markets and games operate, tests his ideas through evidence and hard work, and then puts his “skin in the game” by playing with real cash. Mr. Thorp’s memoir is likely to be appreciated by more than one type of reader. Gamblers and investors will naturally be fascinated by the detail he provides, but those focused on public policy will find his views on the financial crisis compelling and readers less familiar with personal finance will have the bonus of a brief lesson and some actionable advice.
What is card counting, and how does it work in blackjack according to A Man for All Markets?
But one of my other favorite ideas from Munger is that investors should stay within their circle of competence, and only bet big when they have a high conviction understanding. As Buffett has said, he greatly prefers stepping over one foot hurdles to heaving himself over ten foot hurdles. The result of Mr. Thorp’s investigation saved his client from continued participation in the fraud. Mr. Thorp made it known within his network that the Madoff operation was a Ponzi scheme. The establishment at the time would not have believed that Bernie Madoff could be a fraud.
A Man for All Markets by E. Thorp Book Review
Princeton Newport ran into trouble in late 1987 when the IRS and FBI raided the firm’s Princeton headquarters which housed the trading operations. Attorney, was on a campaign to prosecute suspected Wall Street criminals and was looking for information to bolster his case against Michael Milken at Drexel Burnham and Robert Freeman at Goldman Sachs. Several employees of the Princeton office ended up facing charges but no one in the Newport office, run by Mr. Thorp, were ever implicated. Returns in 1988 were only 4 percent as the firm was distracted by the investigation and Mr. Thorp decided to leave at the end of 1988, after which point the partnership eventually wound down. Thorp’s success was not just about innate talent, but a commitment to lifelong learning and self-education. He consistently applied scientific principles to new fields, demonstrating the power of interdisciplinary thinking.
Master Risk Management and Leverage
The fact that Mr. Thorp dedicates this much space in his memoir to personal finance indicates that he believes lack of education in this area is a serious impediment to the well being of the public. He believes that personal finance should be taught in elementary and secondary schools, noting that most people seem to not understand basic probability and statistics. Clearly, if more Americans understood the power of compound growth when leaving high school, there would be far fewer cases of misery caused by mistaken accumulation of debt and lack of savings.
He was a major figure in the securities industry and other attempts to unmask his operation were ignored as well. It is amazing that the Securities and Exchange Commission never uncovered this fraud. At the end, Bernie Madoff turned himself in when it became obvious that the game was over in December 2008. For me the most inspiring aspect of this is that being “self-taught” really seems to be a clear advantage in investing, especially combined with a good grasp of probabilities.
Although it would be comforting to believe that a similar crisis will not occur in the future due to wise regulatory changes, Mr. Thorp seems rather pessimistic regarding the efficacy of the reforms put in place after the crisis. Perhaps his strongest indictment involves the corrupt corporate governance that insulated management at the expense of shareholders and continues to this day. The incentive structures prevalent in corporate America today are largely unchanged and destined to cause trouble in the future.