tech

Edward Thorp: From casinos to financial markets, a true investment god!

2024-06-22

Edward Thorp is a renowned pioneer of market-neutral strategies in the United States and the first person to defeat casinos through card counting. He has written several books, including how to defeat casinos and how to defeat the market. Jack Schwager, who has interviewed many hedge fund magnates, also said that Edward Thorp is the smartest person among the fund managers he has interviewed.

However, many investors in China may be unfamiliar with the name Edward Thorp. Today, let's introduce this financial genius to you.

1. Interest in the financial world began in casinos

Thorp was born in Chicago, USA on August 14, 1932. He has loved gambling since he was a child. At the age of 10, he quickly discovered the trick of increasing the winning rate by changing the handle of the gambling machine while helping the gang watch the gambling machine at the gas station with his cousin.

Advertisement

While pursuing a graduate degree in physics, he was still thinking about roulette gambling, believing that he had the ability to create a machine that could statistically predict the seemingly random movement of the roulette. After graduation, the first thing Thorp did was to go to the Las Vegas casino, where he played the blackjack card game while pondering and studying the rules and loopholes of the game.

After a long period of research, Thorp finally found the trick: big cards like A are very important to the player; while small cards are very beneficial to the dealer, especially the card "5", which is the more the better. So, for ordinary people, you don't have to remember those cumbersome formulas and calculate various different suits of cards. Maybe you even have a poor memory and can't remember phone numbers, but as long as you can remember how many A's and 5's have been played, your winning rate can be greatly improved.

2. The young genius who defeated the casino

"Understanding gambling games such as blackjack is one of the best ways to enter the investment world. You need to learn how to manage money, how to calculate the odds, and how to act when you have an advantage. Gambling is a simple form of investment. Both can be analyzed using mathematics, statistics, and computers. They both require capital management, choosing the appropriate balance between risk and return. Even if everyone's bets are in your favor, if you bet too much, it can still have devastating consequences." - Edward Thorp

Edward Thorp spent two years using early IBM computers and the Kelly formula of probability theory to discover the card counting technique for blackjack, published the paper "The Optimal Strategy for Blackjack", and overnight swept all the casinos in Reno, Nevada, carrying out a "quantitative massacre" on ordinary gamblers, successfully winning tens of thousands of dollars.3. Moving to Wall Street Stock Market

Due to Thorp's unbeatable record in casinos, he was eventually blacklisted and banned from entering. He then shifted his focus to the emerging stock warrant market on Wall Street, using mathematical formulas to create computer programs that identified market mispricings. He used quantitative models to accurately calculate the fair value of warrants, and once they deviated, he would seize the opportunity to place orders.

Thorp believed that gambling was a simplified version of investing. He began to self-study financial knowledge, such as "Security Analysis" by Graham and Dodd. However, Thorp's first investment was not much more sophisticated than that of ordinary people. He bought 100 shares of Outlet at $40 per share, only to watch the price plummet to $20, and it took four years before he broke even.

Thorp discussed with his wife, Vivian, why his first stock investment failed. Vivian analyzed that he had bought a stock he didn't understand, which was no different from deciding which stock to buy with dice. Thorp suddenly realized and began to explore investment methods in the stock market based on mathematical logic.

Soon, Thorp found a way to invest by hedging warrants and stocks. In fact, this method is the widely used arbitrage in later times, but in Thorp's era, it was a brand-new investment approach. Compared to other investment methods, arbitrage is less dependent on the market's unilateral rise or fall. Thorp wrote his ideas in a book called "Beat the Market," and then used this book to persuade 14 partners to establish the Hedge Associates.

In a bull market, Thorp's arbitrage method did not have much advantage. When the bear market came in 1969, the advantages of this investment method began to emerge. Among the funds with a large decline in net value, Thorp and his company still maintained growth. As a result, they established the Princeton Newport Partners in 1969, which was one of the earliest hedge funds. This fund continued to grow in the following years.

Summary

After the stock market crashes of 1973 and 1974, Thorp finally became a millionaire. His family completely changed their lives, and Thorp gradually left academia to become a professional investor.

Throughout his investment career, Thorp fully practiced the way of thinking that applies abstract thinking to real life. Thorp used his life to give an answer, that is, to use mathematical knowledge for gambling and investing, and to make a lot of money.Whether facing gambling or financial market investments, Thorp is using his mathematical knowledge to simplify the process into mathematical models, and then form corresponding strategies and answers. This is actually the "applied problems" we have all encountered in mathematics, but there are very few people who truly apply it to practice like Thorp.