Sometimes, the edge doesn’t always go to the actor who boldly picks the apparently best option, but to the person who adapts to the first mover, and counters with something better. After developing, perfecting and trying his roulette system after blackjack he decided against using it despite its great profitability because he did not want to spend many hours as he then had to do. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute a man for all markets or the author’s employer. This formula promises a life of hard work, but judgment based on evidence is the best road map for anyone practicing finance.
What is statistical arbitrage, and how does Thorp describe it in A Man for All Markets?
His ideas went on to inspire the success of the next generation of great quantitative firms such as D.E. When the top five officers at PNP’s East Coast office were charged with stock manipulation and other white collar crimes in the late 1980s, the system Thorp created did have the resilience to guarantee the firm’s survival. The decentralization of the two offices had let one veer dangerously off track, but the interrelatedness of the two parts meant that neither could survive independently.
He recognized that emotional decision-making could undermine even the best systems, and developed methods to maintain objectivity. Critically, Thorp claims that both offices acted independently, with each exerting full control over their own hiring decisions and cultures. Thorp may have thought that this added a protective layer of redundancy to his business as he often thought deeply about worst case scenario planning in nearly all aspects of his business. Thorp even asked Goldman Sachs what would happen to PNP’s account if a nuclear bomb went off in New York harbor (Goldman allayed his concerns by having a backup system in Colorado).
Embrace the Power of Mathematics and Education
After proving the theory through hands-on testing at the casino tables in Reno, Mr. Thorp published his findings in academic journals as well as in Beat the Dealer, a book that made card counting accessible to the non-technical reader and remains relevant to gamblers today. In his case, there’s also a contrarian streak at play; told, like all of us, that the winning odds are always with the casino and that there’s no way to reliably play against the house, he took the scientific approach and tested the assertion. “I formed the habit of taking the result of pure thought—such as a formula for valuing warrants—and using it profitably,” he writes. His account of making a broker blanch with a daring hedge maneuver during the height of the October 1987 crash is an exercise in learned derring-do, with the upshot that while the S&P dropped by a quarter, he at least broke even during the worst of it and gained in the long term. It’s the kind of thing any would-be investor, to say nothing of casino cowboy, ought to read.
Slow Investing, Special Situations & Occasionally Wild Punts
However, the volume of trading in the stock market makes it clear that the majority of activity has little to do with providing capital to business or allocating capital to its best and highest use. Instead, in the short run, the stock market more closely resembles a casino with players who are interested in making quick gains. Now Thorp shares his incredible life story for the first time, revealing how he made his money and giving advice to the next generation of investors. An intellectual thrill ride, replete with practical wisdom, A Man for All Markets reveals the power of logic in a seemingly irrational world.
But decentralization gives Berkshire a valuable firewall against negative contagions. When bad practices pop up at Wells Fargo, they can’t quickly spread to Kraft-Heinz or even to Omaha. Because no single pillar is central to Berkshire’s success, perhaps no longer even Buffett himself, the company has grown into one of the largest and most stable businesses in the world. What’s remarkable about the non-transitive rule is that it bends the mind away from thinking that issues are always about straight-forward maximization or minimization.
Thorp began his career as an academic mathematician, but his story is one man’s search for an edge at playing games modeled through probabilities. The edge he found in games of chance led to valuable discoveries in finance, successful businesses, wealth, and fame. A Man for All Markets receives praise for its fascinating insights into Thorp’s life, from beating casinos to pioneering quantitative finance. However, some find the book self-aggrandizing and criticize the later chapters for basic financial information. The autobiography is lauded for its engaging anecdotes and Thorp’s unique perspective on markets, though opinions vary on its overall quality and relevance to modern investors.
A few days later, as the team of six left Las Vegas, their car’s accelerator suddenly stuck as they traveled down a mountain road. A terrible “accident” was narrowly averted through use of the emergency brakes. The book starts with some childhood stories which show Ed Thorp as an introverted but clever guy who was most happy tinkering with stuff. He grew up in what we would now call “lower middle class” and had to work hard to get into university. Interestingly, he started studying physics but then switched to math because he could get his phd faster.
- In the idealistic view of economics, the stock market is a venue for providers of capital to invest in promising businesses that have the ability to generate attractive returns on capital.
- Like Mr. Buffett’s instructions to the Gates Foundation, Mr. Thorp insisted that his gift would result in funding for additional research that would not otherwise have been funded through existing financial resources of the university.
- It was in this context that he encountered the Bernie Madoff fraud seventeen years before it ultimately collapsed.
- Born in 1932, he earned his Ph.D. from UCLA and taught at MIT, New Mexico State University, and UC Irvine.
Those who wish to make the attempt must choose between finding managers who can hopefully outperform the market after taking into consideration their fees or must do the work required to personally manage the account. Princeton Newport employed a true “hedge fund” strategy, meaning that it was designed to be market neutral and profitable regardless of the movement in the overall stock market. Today, what we call “hedge funds” are usually not market neutral funds of the type Mr. Thorp ran but are instead usually net long or net short, meaning that managers are taking a directional view of their holdings or the market as a whole. Mr. Thorp focused on identifying opportunities that could be hedged in a way that did not depend on the movements of the overall market. This resulted in a nearly twenty year track record in which the fund never posted a loss over a single calendar quarter. From November 1, 1969 through the end of 1988, Princeton Newport Partners posted an annual compound return of 19.1 percent before fees, and 15.1 percent after fees.
- Thorp makes it clear that achieving an edge is not easy and should not be attempted by most investors.
- They have a strong mutual respect but different views on how to make money — that is, value investing versus relative value.
- The decentralization of the two offices had let one veer dangerously off track, but the interrelatedness of the two parts meant that neither could survive independently.
- 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.
- Thorp even asked Goldman Sachs what would happen to PNP’s account if a nuclear bomb went off in New York harbor (Goldman allayed his concerns by having a backup system in Colorado).
Unfortunately for Thorp, his backup system overlooked how co-dependent the reputation of two separate offices, with two separate bosses and oversight systems could be. Part of the answer has to do with how Thorp and Buffett constructed their backup systems. In Berkshire’s conglomerate model, excellent businesses are acquired, but remain totally unintegrated. This requires that Berkshire forego the “synergies” and cost reductions that typical come with merger integrations. By applying the tools of physics, computer science and math to finance, Thorp created the world’s first “quant shop,” and a trading system that functioned profitably for decades with few drawdowns.
Also in Banking & Finance
Born in 1932, he earned his Ph.D. from UCLA and taught at MIT, New Mexico State University, and UC Irvine. Thorp gained fame for his 1962 book “Beat the Dealer,” which mathematically proved that card counting could overcome the house advantage in blackjack. He pioneered modern hedge fund techniques and collaborated with Claude Shannon to create the first wearable computer in 1961.
He also discusses how, when asked to evaluate Bernie Madoff in the early 1990s, he detected fraud simply by doing his homework and studying the evidence. The relevance of the autobiography may not be immediately apparent to finance-oriented readers, but this unassuming trading wizard champions a combination of basic scientific thinking, problem solving, and dogged determination as his means of finding answers to tough questions. The results are not the ordinary research musings of finance academics.
Both of these ideas are fantastic advice, but Thorp’s book made me realize that when you combine them there is a tension. In knowledge work fields (like investing), the variable you want to maximize is actionable understanding. You have to constantly improve your probabilistic understanding of how events will unfold in the future, while at the same time constraining your faith in your own abilities to understand the things you’ve learned about. You are forced to push and pull in opposite directions—to an extreme degree—at the same time. While Mr. Munger’s own comments from the meeting are worth reading, I’d suggest reading Thorp’s book first. In many ways, Thorp is a second Charlie in terms of both intellectual power and scope, which is perhaps the highest praise I could offer another person.
Master Risk Management and Leverage
Since 2003, size of the endowment has more than doubled after accounting for yearly spending. 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. Thorp makes it clear that achieving an edge is not easy and should not be attempted by most investors. He provides sound advice in recommending that if one cannot find either an edge or a manager who has one, then it is best to hold a diversified, passive portfolio. In such circumstances, he advocates holding Berkshire Hathaway and index funds.