Mathematician. Financial strategist. Wall Street veteran. Best selling author. And the granddaddy of card counting.
That’s Edward Thorp in a nutshell. But let’s learn a little bit more about one of the greatest minds of our time.
Who is Edward Thorp?
Born 14th August 1932, in Chicago, Illinois, Edward O. Thorp began demonstrating his mathematical ability from a young age, with the ability to count the number of seconds in a year by the age of just seven. A curious and experimental child, he tinkered with creating science experiments well beyond his years and the interests of his peers. When he was ten, Thorp and his family relocated to California.
After wrapping up high school he went on to UCLA, graduating with a Bachelor’s degree in Physics in 1953, followed by a masters in the field in 1955. A PhD in Mathematics followed in 1958, driven by a keen interest in gambling and game theory. That same year, he went to Las Vegas over Christmas to test out a strategy developed by army mathematicians that increased the odds of winning in blackjack to almost even – around six-tenths of a percentage point. Blackjack is won by creating a hand of 21 or closest to it.
Based on the results played at the casino, Thorp went back home to study the paper again by the army mathematicians and then got to developing his own strategy. It was with this new idea that Thorp’s star would rise.
Beat the Dealer
Taking up a professorship at MIT, Thorp was able to access the computing power of the IBM 704 to run blackjack experiments. What he found was that if small cards were removed from the deck, favour shifted to the player. When big cards were removed, the favour went to the house. From this, he developed a counting system – counting down for larger cards coming out of the deck, counting up for small cards. When the count reaches a high enough amount, then it’s time to bet. Bet amounts should be calculated based on probabilities.
As an academic, he decided to publish his work rather than make off with secret riches. After ridicule by casinos and mathematicians, even after explaining his methods, he was bankrolled to head to Vegas with about $100k in today’s money by some parties that were interested. After 40 hours of play, he’d doubled that figure using his card counting methods. The system worked.
The now-infamous book, Beat the Dealer, which detailed how to beat the house in blackjack, was published in 1962.
With blackjack games in casinos now going up to 8 decks, as well as a variety of extra rules thrown in, it makes Thorp’s original strategy much tougher to implement successfully and requires more rules.
To the stock market
While investing some of his gambling winnings into the stock market, Thorp observed that he wasn’t very good at getting returns and wondered if he could put similar game theory into play for stocks.
Like gambling, Thorp mused, for the stock market you needed to alter the size of your bets based on the probability of outcomes. After researching, he developed methods of more accurately estimating derivative prices that were routinely mispriced, in the end making a bag of cash for both him and his close friends. From there, Thorp’s hedge fund, Princeton Newport Partners, the first quantitative hedge fund, was born. Around this time he met with Warren Buffet, the world’s most well-known investor. Each was as impressed with the other. Thorp’s fund went on to achieve 19.1% average annual return rates for 20 years. His genius, if not cemented before, surely was now.
1988 saw the end of Thorp’s financial management affairs. The stock market crash of 1987, fictionalised in Black Monday, was behind a lot of funds going out of business. An FBI raid on the fund’s offices when officials were trying to uncover who was involved in the Michael Milken junk bonds saga made Thorp realise that perhaps the business was too corruptible. While all in the office were eventually cleared of misdoings, that wasn’t the point that Thorp cared about in the end.
Across the years, Edward Thorp has published over 60 papers related to casino games, financial systems, and even the world’s first wearable computer. His most recent co-authorship was in 2016 with How Does the Fortune’s Formula -Kelly Capital Growth Model Perform?
A man with an amazing, productive mind spanning over 60 years of work and influencing some of the most famous systems in the world. That’s Edward O Thorp.