Wall Street: The World’s Biggest Casino 
The Life of Edward Thorp

Thorp is a mathematician. It was an early age of computer. He wanted to find some applications in computing. Blackjack, a popular card game, caught his attention. Some other people already used computers to calculate the odds of the game. Thorp found some mistakes in that paper and recalculated the odds. Under optimal strategy, a player has 51% chances of winning. He published the result.

Does his strategy work in real life? He wanted to find out in the casinos. He made an advertisement for financial backing. In the end, two mobsters bankrolled his trip to Reno. He chose Reno over Las Vegas because Reno was a smaller and quieter place.

He had one more problem. The probability of winning will fluctuate during a game. If more of the good cards are in the remaining deck, the odds of winning will increase. The optimal bet should increase as well. By how much? He asked Claude Shannon. Shannon said Kelly wrote a paper about that. Thorp got the paper and figured out the relationship between odds and betting ratios.

The trip went as planned. Thorp made a substantial amount of money. He became well known in the casino industry. Once he found the drink tasting strange while playing in a casino. He knew it’s time to quit. He wrote a book Beat the Dealer, and retired from the casino. The book became a bestseller.

Did he beat the dealer? Initially, yes! Soon casinos changed the rules. They would use six decks of cards, instead of one. They would reshuffle in the middle of a game, instead of playing to the very end. In this way, the house regained its edge over guests. The house has the power to set rules and change rules. It is the ultimate winner. Instead of beating the casino, Thorp’s book became the best promoter for the casino industry.

After leaving casinos, Thorp set his sights on Wall Street, the world’s biggest casino. He read some books and subscribed several investment newsletters. His buying and selling of stocks  didn’t work out. He realized, as a mathematician, his edge was in more technical areas. He started to look into warrants and soon found a lot of mispricing there. He made a good return trading warrants. He tried to convince others to invest with him. But rich people are not easily convinced by a poor man. To attract attention, he, together with Sheen Kassouf, a colleague in the economics department at UC Irvine, wrote a book, Beat the Market, in 1967. With the help of this book, he successfully started a hedge fund with Jay Regan in 1969. 

Did he beat the market? Certainly! The performance of their hedge fund, Convertible Hedge Associates, was stellar. But in 1988, the hedge fund was liquidated due to its involvement in Michael Milken’s case. The returns from his later ventures were low. As he got older, it became increasingly difficult for him to beat the market.

In many ways, Thorp enjoys a very successful life. Yet he is powerless before the giant system. He detected Madoff’s scheme early on. But he made little dent on Madoff’s stellar reputation. He actively promoted Kelly’s theory. But Kelly’s theory is nowhere to be seen in today’s investment textbooks.