In 1961, Edward Thorp, a young mathematician, flew into Washington, DC, to address a meeting of the American Mathematical Society at the Willard Hotel. The normal attendance at such meetings then used to be about 40-50 people. But, for this talk, there was a standing-room-only crowd of hundreds. And not all were mathematicians. There were some who sported sunglasses or gaudy oversized rings and smoked cigars. They were sent by the casinos from Las Vegas and Nevada. Plus, there were some reporters with cameras and notepads. The topic of the talk was fascinating: how to beat the casinos in Blackjack, a game of cards.
Thorp finished his speech explaining how the cards could be counted, explaining his use of probability in figuring out the chances of a sequence of cards coming up and how much to bet progressively, to get an edge. After the talk ended, he placed 50 copies of his speech on the table. “The group surged toward them like carnivores competing for fresh meat,” he recalls in his book, A Man for All Markets: Beating the Odds from Las Vegas to Wall Street. There were demands for a press conference, which was arranged, after which Thorp was televised by a major network and interviewed on several radio programmes. According to Thorp, “The scientists and technical types generally understood and believed the winning strategy l described, but the casinos and some of the press did not. ln a sceptical editorial, the Washington Post wrote: there was a mathematician in town claiming to have a winning gambling system, which reminded them of this ad: Send $1 for a sure-fire weed killer. Back comes a note saying ‘Grab by the roots and pull like hell.’
A casino spokesman said, “When a lamb goes to the slaughter, the lamb might kill the butcher. But we always bet on the butcher.” But not everyone from the press was so negative. A younger reporter for the Post followed up with an interview. He was curious rather than sceptical; sympathetic but probing. His name was Tom Wolfe, who went on to become one of America’s most famous authors. Thorp, at that time, was teaching at Massachusetts Institute of Technology (MIT). During this ride back to Boston, he wondered how his research “into the mathematical theory of a game might change my life. 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.”
Thorp was born poor and grew up in an America which went into World War II, barely having recovered from the Great Depression. Prodigious with numbers and enormously curious, he spent his childhood conducting experiments and playing pranks with flying balloons, radio-controlled devices, and nitro-glycerine. He was the kind of boy who would touch a skillet to check if it was really hot, after his mother told him not to touch it. It was this curiosity that led him to find out if he could count cards and beat the casinos. His curiosity was heightened after he chanced to meet Richard Feynman, the legendary physicist, at a party, who told him that no one had come up with a way to beat the casinos in card games.
Thorp set up a basic system of winning which he tested a few times on his own. After he got his PhD in mathematics, he moved to MIT in 1959 to teach. There he got access to IBM 704 as a research tool to speed up the calculations needed to improve his system. He taught himself computer language Fortran, to execute the equations. At MIT, he met the genius, Claude Shannon, mathematician, electrical engineer and cryptographer, famous for Information Theory and Digital Circuit Design Theory, which created the digital revolution. Shannon was as much of a prankster as Thorp. He practised juggling and uni-cycling and walking over a wire. He also invented the flame-throwing trumpet and a device that could solve the Rubik’s Cube puzzle.
The American Mathematical Society wanted Thorp to get his paper on Blackjack endorsed by a Society member, for which Thorp sought Shannon’s appointment. Shannon’s secretary gave him a few minutes. That meeting of a few minutes spilled over to lunch and further. Thorp and Shannon went on to collaborate to create the world’s first wearable computer to beat the casinos in roulette, by creating complex equations based on the trajectory of the ball. The Blackjack paper turned Ed Thorp into a minor celebrity and caught the interest of Manny Kimmel, a rich professional gambler who, earlier in his life, was a bookie with connections to the underworld. He sought out Thorp and offered to fund his adventures in casinos and split the profits. They visited Reno and Lake Tahoe casinos where Thorp won $11,000 in a single weekend. The casinos got wise and repeatedly threw him out. Thorp would disguise himself in wraparound glasses and false beards. Then, casinos attempted to drug him and even kill him. In 1966, after he perfected his system with other card games as well, such as baccarat and backgammon, Thorp went on to write Beat the Dealer, which sold 700,000 copies and was on the New York Times best-seller list for months.
Thorp left MIT, went to teach at New Mexico State University and then to the University of California, Irvine, where he was a professor from 1965 to 1982. In the late 1960s, Thorp started getting interested in the stock market. He spent the summer of 1964 educating himself by reading books on fundamental and technical analysis and decided that neither of these was useful for him. Interestingly, these are two popular paths among investors even today. Thorp again wanted to somehow do the impossible—reduce risk and increase returns. He achieved this, too, by focusing on obscure financial products such as convertibles and warrants. He developed a mathematical model to determine whether these were mispriced relative to the price of the common stock. Shortly thereafter, Thorp came up with a formula to value options, which he used in investing but never published. In 1972-73, Fisher Black and Myron Scholes published their own options pricing theory, which is famously known as Black-Scholes Theory. For this, Robert Merton and Myron Sholes won the Nobel Prize in 1997. Thorp was ahead of them. But while Scholes helped blow up Long-term Capital Management in 1998, Thorp went on to achieve stellar record with extremely low risk.
In the early-1970s, Thorp started Newport Partners in California, a hedge fund based on quantitative techniques. He soon added an East Coast operation, calling it Princeton Newport Partners (PNP). PNP was a true hedge fund; it identified mispricing, but was designed to be market neutral and profitable, regardless of the overall stock market movement. From November 1969 till the end of 1988, PNP posted an annual compound return of 19.1% before fees, and 15.1% after fees. Not only was Thorp’s return higher than S&P 500’s annual return of 10.2%, but was much less volatile. This is why, remarkably, for the 230 months that the Fund was in operation, it had only three losing months—only an under 1% loss in each! PNP ran into trouble in late-1987 when Rudolph Giuliani, a politically ambitious US attorney, was on a campaign to prosecute suspected Wall Street criminals. Several employees working out of the Princeton office faced charges but not those working at the Newport office, run by Thorp. In 1994, he started Ridgeline Partners which averaged 21% compounded annual return over 10 years, with only 7% annualised volatility. Thorp seems to have not only dealt with the cards that came his way in the casinos but also the ones that life made him play. He dealt with chance with a rare ability to sense risk and return. This is a truly inspirational book from one of the most original minds in the market.
