Book Review: A Man for All Markets

I first learned about Edward O. Thorp while reading "Fortune's Formula" (Poundstone 2006).  In FF, Thorp is portrayed as a brilliant mathematician who decided to focus his attention on games of chance (roulette) and games of probability (blackjack) to gamble against Las Vegas casinos with an edge.  Poundstone wrote a fine book, but much of Ed's humanity, personality and research approach are not well explained. Published just a few months ago, Ed tells his life story from growing up poor during the great depression, to becoming a gambler, mathematics professor, investor and ultimately a philanthropist

Thorp's story begins in the 1930s, his family felt the ravages of the depression and they were often short on money.  From an early age, a number of unusual personality traits and mental abilities became clear. He enjoyed reading and had an outstanding memory.  For example, he was once challenged by a passerby who noticed that Ed was holding a tome on British history that looked much too complicated for him, and asked Ed if he knew anything about the British monarchy.  To his adversary's surprise, Thorp went on to name all British monarchs from Alfred the Great to George VI.  In addition to reading comprehension, Thorp's interest in experimentation was evident from his younger years as well. He enjoyed building radios, model airplanes and using tools to improve his surroundings. This theme would become a defining characteristic of Thorp's life.

From an investment perspective, Thorp's book contains a wealth of wisdom. Common consensus on roulette was that it was a game of pure probability, and given the house's slight edge, unbeatable.  Thorp, knew full well that in theory roulette might be unbeatable, but he wanted to explore it for himself to see if the path of the ball was random as theory suggests or if there might be some patterns/path dependency present on the table.  Thorp decided to tackle the roulette wheel by approaching the problem as an experimentalist.

Thorp bought a few old roulette wheels and began exploring for patterns recording where the ball ended up after a normal spin.  He then learned Fortran to run computer simulations on the data he obtained.  These experiments implied that there were patterns to the balls, but he'd need a computer to help him identify them.  This finding resulted in Thorp inventing the world's first known wearable computer which helped him make real-time calculations and gave him an edge betting at the roulette table.  Thorp developed new techniques and equipment as needed to recognize patterns in data and used theory to codify his results into a betting strategy that could be carried out in real casino conditions.  This involved practicing with his friends and in casinos with small amounts of money to see if he could execute his strategy in a risk controlled manner.  Once satisfied with his results, he slowly increased his bet size. 

Later, Thorp would apply an open minded experimentalist approach to investing in securities, commodities and other financial products on Wall Street.  The prevailing wisdom among academic economists and financial theorists at the time was that market prices were efficient, that is to say, that all prices were right.  One of the implications of this theory of securities prices was that there are no patterns in securities prices which could lead to sustained arbitrage profit. As Thorp admits, this is a fine theory, but to test it you need to examine the data and see if there are in fact any patterns.  Thorp shows again and again throughout his story that this theory is false.  From investing in closed-end funds trading at a discount, statistical and fundamental arbitrage techniques and other well-known techniques in the vein of Benjamin Graham are tradable and produce a positive return.  Thorp's several decades of success should give any proponent of the efficient market hypothesis pause.  Thorp's success inspired many other mathematician run investment partnerships that were able to invest in systematically mispriced securities.  Several of these groups were likely trading on the so-called "Black-Scholes" model for more than a decade before Black and Scholes published their result.

In addition to investing on his own, he was one of the first to run a fund of funds.  He invested with many others including Warren Buffett (early in Buffett's career), believing that detecting skill in pricing securities is ex-ante observable, but requires extensive due diligence.  When contemplating an investment in another investor's partnership, Thorp would visit the fund's office and in some cases ask the investor to work from his office for several months.  His process for reviewing an investment manager included reviewing trade ideas in detail and assessing their thinking for rigor and creativity.  This kind of due diligence approach led him to recognize Bernie Madoff as a Ponzi scheme decades prior to the scheme's collapse.

Thorp's book ends with some thoughts on the importance of science.  One of Thorp's central concerns is that the US may be losing its future edge in science, mathematics, and technology because of a pattern he's observed in labor markets. Thorp notes that America which during the 20th century was viewed as the place which caused brain-drain in other parts of the world, such that brilliant people would leave their home countries and go to America to seek their fortune.  Thorp notes that today, the opportunities for brilliant scientists (given the US-visa system and lack of funding) may be better in China than the US.  He's observed a concerning pattern where many top talents are being educated in the US and then returning to their home countries.  Ultimately, this lost potential could result in the decline of America's role in the economy as a leading innovator.  Thorp notes that while Rome was not built in a day and did not fall in a day, a slow decline due to reverse brain-drain is deeply concerning.

In summary, I'd strongly recommend Ed's book if you are interested in games of chance, strategy, investing, seeing applications of the scientific method to human problems and spend time with a man who cares deeply about education and acting morally.  Thank you for taking the time to write "A Man For All Markets" Ed, your experimental approach rooted in your tendency to not believe what others tell you unless you check it for yourself is inspiring to me. Perhaps this is why Seth Klarman named his horse "Read the Footnotes."

Please pick up a copy of Ed's book today.