Founders
Episode 93 #93 Ed Thorp (A Man for All Markets)
Founders

Episode 93: #93 Ed Thorp (A Man for All Markets)

Founders

Episode 93

#93 Ed Thorp (A Man for All Markets)

David Senra is the host of Founders, where he studies history's greatest entrepreneurs. This is what he learned from reading A Man for All Markets: From Las Vegas to Wall Street, How I Beat the Dealer and the Market by Edward Thorp.

What I learned from reading A Man for All Markets: From Las Vegas to Wall Street, How I Beat the Dealer and the Market by Edward Thorp.

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[0:01] 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 also known to be a generous man, intellectually speaking, eager to share his discoveries with random strangers.

[1:23] 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.

[3:19] Ed was initially an academic, but he favored learning by doing, with his skin in the game. When you reincarnate as practitioner, you want the mountain to give birth to the simplest possible strategy, and one that has the smallest number of side effects, the minimum possible hidden complications.

[4:33] As Warren Buffet said: “In order to succeed you must first survive.” You need to avoid ruin. At all costs.

[6:48]  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.

[7:51] Read the forward by Nassim Taleb

[9:14] Ed’s 4 rules for learning

First, rather than subscribing to widely accepted views—such as you can’t beat the casinos—I checked for myself.

Second, since I tested theories by inventing new experiments, I formed the habit of taking the result of pure thought—such as a formula for valuing warrants—and using it profitably.

Third, when I set a worthwhile goal for myself, I made a realistic plan and persisted until I succeeded.

Fourth, I strove to be consistently rational, not just in a specialized area of science, but in dealing with all aspects of the world. I also learned the value of withholding judgement until I could make a decision based on evidence.

[11:15] I admired the heroes who, through extraordinary abilities and resourcefulness, achieved great things. I may have been inspired to mirror this in the future by using my mind to overcome obstacles.

[14:29] They told us that my aunt Nona and her husband had been beheaded in front of their children.

[16:45] At its core, this is a book about how to live well.

[17:55] Ed develops simple systems for everything in his life.

[20:37] If anyone knew whether physical prediction at roulette was possible, it should be Richard Feynman. I asked him, “Is there any way to beat the game of roulette?” When he said there wasn’t, I was relieved and encouraged. This suggested that no one had yet worked out what I believed was possible. With this incentive, I began a series of experiments.

[21:15] “Try to figure out what your skill set is and apply that to the markets.” Thorp likes to stay within his circle of competence. This is a hallmark of people who are rational. In that sense, Thorp reminds me of Warren Buffett. A Dozen Things I learned from Ed Thorp

[21:50] I also believed then, as I do now after more than fifty years as a money manager, that the surest way to get rich is to play only those gambling games or make those investments where I have an edge.

[23:50] He wrote a book that sold over a million copies: Beat the Dealer: A Winning Strategy for the Game of Twenty-One

[26:48] In the abstract, life is a mixture of chance and choice. Chance can be thought of as the cards you are dealt in life. Choice is how you play them.

[27:52] Ed’s philosophy on life: My thoughts then were much like I expected his to have been: that acknowledgment, applause, and honor are welcome and add zest to life but they are not ends to be pursued. I felt then, as I do now, that what matters is what you do and how you do it, the quality of the time you spend, and the people you share it with.

[30:01] Even though the Goliath I was challenging had always won, I knew something no one else did: He was nearsighted, clumsy, slow, and stupid, and we were going to fight on my terms, not his.

[33:09] A good defense keeps other people from taking your money.

[36:39] History doesn’t repeat, human nature does: The frauds, swindles, and hoaxes, a flood reported almost daily in the financial press, have continued unabated during the more than fifty years of my investment career. But then, hoaxes, scams, manias, and large-scale financial irrationalities have been with us from the beginnings of the markets in the seventeenth century.

[40:24] You are unlikely to have an edge on anything you hear in the news.

[46:24] As we chatted about compound interest, Warren gave one of his favorite examples of its remarkable power, how if the Manhattan Indians could have invested $24, the value then of the trinkets Peter Minuit paid them for Manhattan in 1626, at a net return of 8 percent, they could buy the land back now along with all the improvements. Warren said he was asked how he found so many millionaires for his partnership. Laughing, he said to me, “I told them I grew my own.”

[52:07] How Ed selected employees: For this to work, I needed people who could follow up without being led by the hand, as management time was in short supply. Since much of what we were doing was being invented as we went along, and our investment approach was new, I had to teach a unique set of skills. I chose young smart people just out of university because they were not set in their ways from previous jobs. Better to teach a young athlete who comes fresh to his sport than to retrain one who has learned bad form.

[57:13] Life is really about spending time well.

[1:01:45] When Princeton Newport Partners closed, Vivian and I had money enough for the rest of our lives. Though the ending of PNP was traumatic for us all, and the future wealth destroyed was in the billions, it freed us to do more of what we enjoyed most: spend time with each other and the family and friends we loved, travel, and pursue our interests. Taking to heart the lyrics of the song “Enjoy Yourself (It’s Later than You Think),” Vivian and I would make the most of the one thing we could never have enough of—time together. Success on Wall Street was getting the most money. Success for us was having the best life.

[1:04:30] 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 for roulette, or launch a market-neutral hedge fund.

[1:07:19] As Benjamin Franklin famously said, “Time is the stuff life is made of,” and how you spend it makes all the difference.

[1:07:37] Whatever you do, enjoy your life and the people who share it with you, and leave something good of yourself for the generations to follow.

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#93 Ed Thorp (A Man for All Markets)

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.

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