Believing in the common wisdom can be a dangerous thing. Ed Thorp, the college math professor who parlayed his skill at blackjack into a quantitative approach to investing that revolutionized Wall Street, lays out the lesson in great detail in his new book, “A Man for All Markets,” published in January by Random House. Thorp writes how being largely self-taught led him to think differently:
“First, rather than subscribing to widely accepted views — such as you can’t beat the casinos — I checked for myself. Second, since I tested theories by inventing new experiments, I formed the habit of taking the result of pure thought — such as a formula for valuing warrants — and using it profitably.”
In addition, Thorp writes, “I strove to be consistently rational, not just in a specialized area of science, but in dealing with all aspects of the world. I also learned the value of withholding judgement until I could make a decision based on evidence.”
On his first visit to Las Vegas he was struck by the glitter and glamour of the strip, in sharp contrast to the homeless people in the parks. It was a place where “winners were celebrated as poster-people to draw more suckers while a great number, betting too much or too often, were impoverished and sometimes even ruined.”
A few years later Thorp played a bit of blackjack himself, losing $8.50 of a $10 stake, but coming out with a valuable nugget of knowledge. “The atmosphere of ignorance and superstition surrounding the blackjack table that day had convinced me that even good players didn’t understand the mathematics underlying the game. I returned home intending to find a way to win.”
Thorp, the skeptic, notes that “the belief that casinos must come out ahead in the long run was supported by conventional wisdom, which argued that if blackjack could be beaten, the casinos would have to either change the rules or drop the game. Neither had happened. But . . . I wasn’t willing to accept these claims about blackjack. I decided to check for myself if the player could systematically win.”
Thorp’s strategy is outlined in detail in his 1962 book, “Beat the Dealer.” In a nutshell Thorp devised a simple way of valuing cards as they flew out of the dealer’s hand, so that he could judge at any moment whether the cards remaining to be dealt would be more favorable to him or to the dealer. Thorp would bet more heavily when the deck was in his favor, and bet only the minimum when it was not.
The system was good enough that Thorp found himself augmenting his salary as a mathematics professor. He decided to invest some of his money in the stock market. He bought $4,000 worth of stock in a manufacturer of car batteries. The business press was touting the company’s bright future, with promises of technological breakthroughs that would lead to increased sales. In two years the stock fell to half its original price. Thorp decided there had to be a better way. And with Jay Regan, the new idea became a business.