Blackjack: A Wall Street Tale: You Should Know Your Investors

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Get to Know Us. English Choose a language for shopping. Amazon Music Stream millions of songs. This copy is for your personal, non-commercial use only. To order presentation-ready copies for distribution to your colleagues, clients or customers visit http: In , the young writer Tom Wolfe wrote a sympathetic profile in the Washington Post about a year-old mathematician who had learned how to beat the house in blackjack.

The mathematician, Edward Thorp, described how to figure out the sequence of the cards and how to bet accordingly. The story went viral. And Thorp, who taught math at the Massachusetts Institute of Technology and then at the University of California, Los Angeles, became an instant celebrity who wrote best-selling books about his techniques.

How Ed Thorp Delivered 20% Returns For 30+ Years

In fact, Fischer Black and Myron Scholes used a key idea from one of those books for their formula to price options; Scholes, along with Robert Merton won the Nobel Prize. Thorp also invented a wearable computer that could beat the casino at roulette. Soon, he took what he knew and began applying it to the stock market and taking private clients. One early admirer was Warren Buffett, who having briefly shut down an early money management vehicle because stocks were too expensive, advised a client to sign on with Thorp.

In , Thorp opened Princeton Newport, a quant fund that returned A few years later, Thorp started a new statistical arbitrage fund using techniques he discovered in All along, Thorp has been writing his books, including the entertaining and informative memoir A Man for All Markets , which comes out in paperback next month. We caught up with Thorp, now 85, just before he left for a hiking vacation in New Zealand.

In this first part of the wide-ranging interview, he told us how stock markets are like casinos, and why index investing is worth it.

Keep reading for more. In high school, it occurred to me that the roulette ball moves in a stately orbit like a planet.

Learning from Ed Thorp — Investment Masters Class

I thought it might be predictable. I did a lot of doctoral work in physics, and was convinced I could predict from the motion of the ball and the spinning rotor roughly where the ball would fall, and if I did so I would have a huge advantage. I went to the casinos in Christmas of , and while there I read an article from a statistics journal that showed how to play blackjack so you lost slowly.

I decided the game was beatable essentially by keeping track of the cards. So I got all the information from the people who wrote the article, improved their calculations, and used those calculations to figure out how to count cards.

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I was at M. The only way not make of money is to lose 10 straight hands in a row, and since losing 10 straight hands in a row is extremely unlikely, you expect to almost always make the dollar you were hoping for.

Guest post: Michael Geismar’s blackjack strategy

By not following their advice, you have around a In fact because the amount you would lose when you get ten bad hands in a row is so catastrophically high, the expected amount you win overall is still negative. The two methods of trying to adjust the outcome of the game have parallels in investing. This is analogous to how the MIT team was trying to predict how a hand of blackjack will play out before it gets dealt.

In both cases they are using special knowledge of the situation to increase the underlying probability of success. Alternatively, when a bank sets up a hedge against one of their investments, they are trying to decrease the number of possible outcomes in which they lose money. For example the bank may hedge its investment in Microsoft by shorting Google. If they both drop in price, the short on Google will cancel out the losses on Microsoft.

But at this point, to get the same level of return as investing in just Microsoft, they will have to increase their leverage.

Ed Thorp Talks Roulette and Financial Market Investment

Once the bank has increased their leverage, this becomes similar to the betting strategy in blackjack. Just like the person using a betting strategy, they have pushed their risk to the tail events: Unless you watch them play, there is really no way for you to know if they are actually changing the game like the MIT students, or if they are just employing a betting strategy and at some point will lose all of your money.

This lack of information is a problem for clients trying to get a good return from a bank, and also a problem for banks CEOs trying to ensure their company has a good return. Once other investors saw that the Whale left a chance for his investment to go sour, they were able to take actions to exploit this, and caused the event that seemed unlikely to come to pass. After hearing Ben Mizrech speak, Geismar was seen using a betting strategy to try and improve his winnings at the blackjack table. After a losing hand he would lower his bet. This betting strategy has the opposite effect the one described before; instead of having a single win wipe out previous losses, a single loss will wipe out much of the earlier winnings.