Transcript
Introduction
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's 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 and 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 coconspirator 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. 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 du jour 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 its sophisticated research into simple rules. Go to a blackjack table. Keep a tally. Start with 0. Add 1 for some strong cards, minus 1 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 2 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. So the world today is divided into 2 groups using 2 distinct methods.
The first method is that of the economists who tend to blow up routinely or get rich collecting fees for managing money, not from direct speculation. Consider that long-term capital management, which had the crème de la crème of financial economists, blew up spectacularly in 1998, losing a multiple of what they thought the worst case scenario was. The second method, that of the information theorists as pioneered by Ed, is practiced by traders and entrepreneurs and scientists. Every surviving speculator uses explicitly or implicitly this second method. I said every because those who don't will eventually go bust.
Some additional wisdom I personally learned from Thorp, many successful speculators after their first big break in life get involved in large-scale structures with multiple offices, morning meetings, coffee, corporate intrigues, building more wealth while losing control of their lives, not Ed. After the separation from his partners and the closing of his firm, for reasons that had nothing to do with him, he did not start a new mega fund. He limited his involvement in managing other people's money. But such restraint requires some intuition, some self-knowledge.
It is vastly less stressful to be independent. And one is never independent when involved in a large structure with powerful clients. It is hard enough to deal with the intricacies of probabilities, you need to avoid the vagaries of exposure to human moods. True success is exiting some rat race to modulate one's activities for peace of mind. Thorp certainly learned this lesson. The most stressful job he ever had was running the math department at the University of California, Irvine. You can detect that the man is in control of his life. This explains why he looked younger the second time I saw him in 2016 than he did the first time I saw him in 2005.
Okay. So that was an excerpt. It was written by Nassim Taleb from the book that I read this week, which is the autobiography of Ed Thorp. The book is called A Man for All Markets: From Las Vegas to Wall Street, How I Beat the Dealer and the Market. You could actually read the entire forward that Taleb wrote for the book for free. He posted it on his Medium page, and I will link to it in the show notes. Now this is the sixth part of a series that I'm doing that started back on Founders #88, which covered -- which is when -- it's a podcast I did that -- when I read every single shareholder letter Warren Buffett has ever written. And in the past few weeks, I've read books about people Warren Buffett mentioned and admired. And I do this to try to deepen my understanding of how Buffett thinks and the kind of ideas and people that he favors. And Ed Thorp is one of those people.