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I Liked Edward Thorp's Book: A Man for All Markets

Comments on A Man for All Markets: From Las Vegas to Wall Street, How I Beat the Dealer and the Market, by Edward Thorp. Bold formatting is added by me.

The professor, the son of a famous physicist, was himself a mediocrity. Because he was insecure and afraid of questions from the class, he copied his lectures from a stack of note cards onto the board, turning his back to the class to discourage interaction. Then we recopied them into our notebooks. He had been doing this for years, and the content seldom changed. This seemed stupid to me. Why not just hand out copies so we could read them in advance and come to class with intelligent questions? Of course, he was afraid someone might ask him a question he couldn’t answer.


By the time I met with the professor in his office to apologize [for criticizing his bad teaching], I realized I had behaved stupidly and rudely, and told him truthfully that what I did was improper and I regretted my actions. But there was still the more serious matter of what I had said about his teaching. I had damaged his self-esteem. He would never forgive this unless he felt I retracted what I had said. My own values and sense of self-worth made me unwilling to grovel and tell lies, despite the personal stakes. I had to find another way. I explained that I had come to realize that his teaching methods were unique and that students, though they may not always appreciate it, rarely encounter a professor of his caliber. What I said was true but allowed more than one interpretation. He picked the one I expected him to choose. He was beaming when I left, my career was saved, and I would become a better-behaved and somewhat more mature person.

Misleading people while making technically true statements is a silly game. I don't think it's honest.

Dominique Francon does something similar in her columns praising Howard Roark in The Fountainhead (the public reads them negatively).

While I was at UCLA, my PhD thesis adviser, Angus Taylor, suggested that I send some of my mathematical work to a well-known California mathematician for his comments. I got no response. But eleven months later at a Southern California meeting of the American Mathematical Society, Taylor and I heard the great man talk. The subject was my discovery, in detail, presented as part of his original work, and it was also about to appear under his name in print, in a well-known mathematical journal. Both of us were stunned. Taylor, who would later become academic vice president of the entire University of California system, was an ethical and experienced mathematician to whom I looked for guidance, but he didn’t know what to do. So neither of us did anything.

Academia is full of frauds.

When the screening committee received my abstract, their near-unanimous reaction was to reject it. I learned this later from John Selfridge, a number theorist whom I had known at UCLA and a member of the committee. For a while, he held the world’s record for finding the largest known prime number. (A prime is a positive whole number divisible only by itself and one. The first few are 2, 3, 5, 7, 11, 13…) Fortunately, Selfridge persuaded them that I was a legitimate mathematician and that if I said it was true, it likely was.

Why would the committee reject my talk? Professional mathematicians regularly receive claims that the sender has solved some famous problem, claims that almost always turn out to be from cranks, from the mathematically uneducated unaware of what’s already been done, or that include proofs containing simple errors....

... obviously, if the casinos could be beaten they would either change the rules of the game or go out of business. No wonder the committee was inclined to reject my abstract. Ironically, their reason for doing so—that mathematicians had apparently proven that winning gambling systems were impossible—was my strongest motivation for showing it could be done.

The academic screening committee was full of frauds. They didn't review the ideas, they just assumed there were simple errors. And they never changed their mind about judging math by reputation, they just changed their judgement of Thorp's reputation after Selfridge vouched for Thorp.

This trip taught me that while playing well, even with experts to warn me of dirty dealing, I could no longer openly win a significant amount. On future visits, I would need to change my appearance, be low-key, and generally avoid drawing attention to myself. Mickey MacDougall told the gaming control board that he saw more cheating in Nevada casinos while watching my eight days of play than he had seen in all his previous five years of working for the board. After his damning report he was never again asked to consult by them.

The Nevada gaming control board was full of fraud (in 1962). They turned a blind idea to casinos defrauding customers with methods like using dealers who cheat when shuffling and dealing. In one case in the book, the cheating dealer made a mistake with her physical dexterity and accidentally made it plainly visible that she was dealing the second card from the top to Thorp. An agent supposed to police cheating casinos was present, but pretended not to notice.

Karl Pearson (1857–1936) discovered that the roulette numbers being reported daily in a French newspaper showed exploitable patterns. The mystery was resolved when it was discovered that rather than spend hours watching the wheels, the people recording the numbers simply made them up at the end of each day. The statistical patterns Pearson detected simply reflected the failure of the reporters to invent perfectly random numbers.

Some newspaper employees committed fraud too.

In fifty-five and a half years of marriage I don’t ever remember her [Thorp's wife, Vivian] bragging. The closest she came was when I would admire the way she matched the hues of her outfits or furnished our household with a designer’s eye. She would look at me and matter-of-factly explain, “I have a good eye for color.”

It's common that women believe they're good at that, but aren't. It takes skill, but people who have done nothing to develop any serious expertise often think they're good at it. Maybe Vivian is a rare exception (or read books and took classes, which Thorp didn't mention). But I doubt it. I think she's bragging because it's culturally acceptable for women to think they're good at this without seeming arrogant (and this cultural situation, not actual skill, is the key factor). Thorp himself seems to be pleased that his wife wasn't arrogant in general – and also be OK with her bragging about this (which he refuses to even say is bragging, he says it only came close to bragging).

the Math Department [at the University of California at Irvine] was headed for serious trouble. Both the levels of grant money for research and funds from the state of California to support the university had declined. This led to fierce struggles among various factions in the department for what was left. To mediate the infighting, an outsider was brought in as a chairman. He was forced out after three turbulent years. For want of anyone else who might be acceptable to the warring groups, and against my better judgment, I was persuaded by the administration to act as temporary chairman.

The assignment was worse than I thought. I found that one assistant professor had stopped showing up to teach, dividing his time between his girlfriend four hundred miles to the north in the San Francisco Bay Area and the casinos in Reno and Lake Tahoe. A card counter, he even called me with blackjack questions! Another assistant professor was running up departmental phone bills of $2,000 per month versus a total of $200 for the other twenty-five professors combined. When I confronted him he claimed it was mathematical research. A review of the bills showed almost all the charges were for calls to two numbers in New York City. I dialed each, speaking in turn to his mother and to a store that sold musical recordings. He was enraged at me and not at all embarrassed when exposed.

Meanwhile, a full professor had stolen the confidential employment records of another full professor from the department files. When I discovered this and confronted him, he refused to return it. It turned out that the file contained a very nasty letter that he had written about his enemy. He feared that if I, as chairman, learned what he had done, I would expose him. When I asked the administration to initiate disciplinary action against these incorrigibles, they declined to act. I was stunned and stymied.

One problem in large bureaucracies is that many of the members decide it is better not to cross people, instead of standing on principle. I asked a good friend, whom I had helped to get an appointment in our department, to become my vice chairman and help me. Although he was now a full professor with tenure, he declined, saying, “I have to live in the same cage with these monkeys.” I did understand his point. On the other hand, I was not confined to the cage. I had PNP [Thorp's hedge fund]. I thought, Why try to fix this if no one will even back me up? I was in the Math Department by choice, not by necessity. It was time to move on.

This is a good indication of how bad academia is.

To my astonishment, I found that XYZ Corp was offering to sell me options at less than half my expected payoff! After I collected financial statements from my friendly salesman and examined them, I discovered that when XYZ Corp sold an option it counted the proceeds as income, but did not set aside any reserve to pay off the options if and when they were cashed in by the buyer. Since the correct reserves on each option they sold should have been more than twice what they were being paid, proper accounting would show their net worth becoming more negative every time they sold another option.

It was clear that they had to sell more and more options, using the increasing cash flow to pay off any early “investors” who might cash in. Classic Ponzi, and bound to end badly. What to do?

I decided on a little educational experiment. After reviewing the scanty information available on sales, options outstanding, and early redemption rates, I estimated the company would survive for at least eight more months. It turned out to be ten. Buying $4,000 worth of six-month options, I doubled my money in four months and cashed out. A few months later the offices were shuttered, the operators gone, and another fraud investigation was under way.

This time, Thorp profited from a fraud.

I figured out a solution. I called our head trader, who as a minor general partner was highly compensated from his share of our fees, and gave him this order: Buy $5 million worth of index futures at whatever the current market price happened to be (about 190), and place orders to sell short at the market, with the index then trading at about 220, not $5 million worth of assorted stocks—which was the optimal amount to best hedge the futures—but $10 million. I chose twice as much stock as I wanted, guessing only about half would actually be shorted because of the scarcity of the required upticks, thus giving me the proper hedge. If substantially more or less stock was sold short, the hedge would not be as good but the 15 percent profit cushion gave us a wide band of protection against loss.

I went through a detailed explanation of my outside-the-box analysis of why this trade was a windfall opportunity. But this day was beyond anything our trader had ever seen or imagined. Gripped by fear, he seemed frozen. He refused to execute the trades. I told him to do it for PNP and do it now, or else I wanted him to do it for my account. If that was his choice, I told him I would later tell all the other partners how the profit I made would have, but for him, belonged to the partnership rather than to me.

Here was my reasoning. If, because of the uptick rule, only about half the shorts got off, then we would be properly hedged and make about $750,000. If none got off (extremely improbable), we were buying the futures at an enormous discount—the index itself would have to fall more than another 13 percent before we began to lose. At the other extreme, especially in a market panic, there was virtually no chance all the shorts would go off. Even if all the orders to sell short were completed, the market would have to rise more than 14 percent for us to lose money. To protect against this possibility, I told my head trader that when we filled close to half the short-sale orders, he should cancel the rest. After he finally complied with my request and completed the first round, I ordered a second round of the same size. In the end we did get roughly half our shorts off for a near-optimal hedge. We had about $9 million worth of futures long and $10 million worth of stock short, locking in $1 million profit. If my trader hadn’t wasted so much of the market day refusing to act, we could have done several more rounds and reaped additional millions.

Thorp's hedge fund lost millions of dollars because their stock trader didn't do his job. It's interesting to me how much dealing with people played a role here. Thorp couldn't just decide what to buy and sell, he had to persuade someone to do it (by threats, because explaining why it was profitable didn't work), even though the trader would not be affected by the outcomes of the trades and it was his job to make the trades Thorp chose.

I also found it interesting how little control Thorp had over what he bought. He ordered twice what he wanted figuring it wouldn't all happen. Why not just tell the trader to keep going until he gets to the amount Thorp actually wants?

See also my previous post on the book, School Mistreated Edward Thorp.

Elliot Temple on May 12, 2018


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