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**
A Man for All Markets
** by
Edward O. Thorp

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3Com Palm IPO, Albert Einstein, asset allocation, beat the dealer, Bernie Madoff, Black Swan, Black-Scholes formula, Brownian motion, buy low sell high, carried interest, Chuck Templeton: OpenTable, Claude Shannon: information theory, cognitive dissonance, collateralized debt obligation, compound rate of return, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Edward Thorp, Erdős number, Eugene Fama: efficient market hypothesis, financial innovation, George Santayana, German hyperinflation, Henri Poincaré, high net worth, High speed trading, index arbitrage, index fund, interest rate swap, invisible hand, Jarndyce and Jarndyce, Jeff Bezos, John Meriwether, John Nash: game theory, Kenneth Arrow, Livingstone, I presume, Long Term Capital Management, Louis Bachelier, margin call, Mason jar, merger arbitrage, Murray Gell-Mann, Myron Scholes, NetJets, Norbert Wiener, passive investing, Paul Erdős, Paul Samuelson, Pluto: dwarf planet, Ponzi scheme, price anchoring, publish or perish, quantitative trading / quantitative ﬁnance, race to the bottom, random walk, Renaissance Technologies, RFID, Richard Feynman, Richard Feynman, risk-adjusted returns, Robert Shiller, Robert Shiller, rolodex, Sharpe ratio, short selling, Silicon Valley, statistical arbitrage, stem cell, survivorship bias, The Myth of the Rational Market, The Predators' Ball, the rule of 72, The Wisdom of Crowds, too big to fail, Upton Sinclair, value at risk, Vanguard fund, Vilfredo Pareto, Works Progress Administration

building the first one The MIT Media Lab timeline erroneously gives the year 1966 for our computer, probably because I first revealed its existence in the 1966 revised edition of Beat the Dealer. However, the correct year is 1961, when we completed and successfully tested it in Las Vegas, as explained in numerous subsequent publications, and verified in correspondence dated August 1961, between Shannon and me, now in the archives of the MIT Museum. The device itself also remains at the museum. few early players Among them were Emmanuel Kimmel (Mr. X of Beat the Dealer), Jesse Marcum (the “little dark haired guy from Southern California” in Beat the Dealer), Russell Gutting (“Junior”), Benjamin F. (“System Smitty”) Smith, and Mr. F. (who I was told was Joe Bernstein, the “silver fox” in columnist Herb Caen’s book Don’t Call It Frisco).

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The next part of the story begins back in 1966 when a senior at Duke University had a horrible automobile accident. He lost his scalp and most of his blood. Fortunately a state trooper found the scalp and it was reattached. It took a long time for his body to heal. While spending much of his senior year in the hospital, he read Beat the Dealer. That summer, between graduation and an upcoming three-year enlistment in the navy, he ignored his mother’s advice to the contrary and went to Las Vegas as one of the early card counters. Using Beat the Dealer as a guide, he brought a bankroll of $200 and ran it up to $10,000. It took four months. The grueling days at the green felt tables often lasted sixteen hours. It was a hard way to earn money but the real value, as with so many before and after him, was in what the young man learned. As he later said, “I had no clue that my four months at the tables in Las Vegas were to lay the foundation for a successful career in Wall Street.

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working for the board He wrote about our experience in a syndicated column titled “Even ‘Honest’ Vegas House Cheats.” bits of publicity E.g., Time, “Games: ‘Beating the Dealer,’ ” January 25, 1963, p. 70. “It's Bye! Bye! Blackjack” appeared Scherman, 1964. a nine-page story O’Neil, Paul. “The Professor Who Breaks the Bank,” Life, March 27, 1964, pp. 80–91. a heart attack In April of 1966. thwart these card counters Vic Vickery, “Counting on Blackjack,” Las Vegas Style magazine, May 1993, pp. 61, 67. Players Too Smart Carson City (UPI): New York Journal-American, April 3, 1964. CHAPTER 8 High–Low System I called this the Complete Point Count in Beat the Dealer. pooling their bankrolls For the optimal trade-off between risk and return, the bet size in a given situation is proportional to bankroll.

**
The Quants
** by
Scott Patterson

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Albert Einstein, asset allocation, automated trading system, beat the dealer, Benoit Mandelbrot, Bernie Madoff, Bernie Sanders, Black Swan, Black-Scholes formula, Bonfire of the Vanities, Brownian motion, buttonwood tree, buy low sell high, capital asset pricing model, centralized clearinghouse, Claude Shannon: information theory, cloud computing, collapse of Lehman Brothers, collateralized debt obligation, commoditize, computerized trading, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, Donald Trump, Doomsday Clock, Edward Thorp, Emanuel Derman, Eugene Fama: efficient market hypothesis, fixed income, Gordon Gekko, greed is good, Haight Ashbury, I will remember that I didn’t make the world, and it doesn’t satisfy my equations, index fund, invention of the telegraph, invisible hand, Isaac Newton, job automation, John Meriwether, John Nash: game theory, law of one price, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, margin call, merger arbitrage, money market fund, Myron Scholes, NetJets, new economy, offshore financial centre, old-boy network, Paul Lévy, Paul Samuelson, Ponzi scheme, quantitative hedge fund, quantitative trading / quantitative ﬁnance, race to the bottom, random walk, Renaissance Technologies, risk-adjusted returns, Rod Stewart played at Stephen Schwarzman birthday party, Ronald Reagan, Sergey Aleynikov, short selling, South Sea Bubble, speech recognition, statistical arbitrage, The Chicago School, The Great Moderation, The Predators' Ball, too big to fail, transaction costs, value at risk, volatility smile, yield curve, éminence grise

Thorp fielded a flood of requests about the nature of his system, as well as offers to back him. One of the most generous came from a New York businessman who promised to pony up $100,000. Thorp was eager to test his theory, but he didn’t think he needed that much cash. He decided to accept $10,000 and promptly headed for Reno. The same day Thorp beat the dealer in that ratty Reno casino at five in the morning, he awoke in the afternoon eager to continue his experiment. After a hearty meal, he met with one of his financial backers, known as the mysterious “Mr. X” in the book he would later write detailing his system, Beat the Dealer. Later that day, a “Mr. Y” arrived. Mr. X was, in fact, a New York businessman with connections to organized crime. His name was Emmanuel “Manny” Kimmel, a short, white-haired racketeer with his fingers in everything from numbers games in Newark, New Jersey, to East Coast horse tracks.

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The combination of Thorp’s winning blackjack model and Kelly’s optimal betting system was powerful. Thorp and Kimmel continued to beat the dealer, despite a number of hurdles thrown their way. After several days, they had more than doubled their initial $10,000 stake. Soon after Thorp announced his results in Washington, D.C., he was watching a TV program about gambling. A reporter asked a casino owner whether gambling ever paid off. “When a lamb goes to the slaughter, the lamb might kill the butcher,” the owner said. “But we always bet on the butcher.” Thorp smiled. He knew that he’d beaten the butcher. As he would later write: “The day of the lamb had come.” After his first excursion to Vegas, Thorp began work on Beat the Dealer. Published in 1962, the book quickly became a New York Times bestseller—and struck terror into the heart of casino bigwigs everywhere.

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Thorp had calculated that when the ratio of tens left in the deck relative to other cards increased, the odds turned in his favor. For one thing, it increased the odds that the dealer would bust, since dealers always had to “hit,” or take another card, when their hand totaled sixteen or less. In other words, the more heavily a deck was stacked with ten cards, the better Thorp’s chances of beating the dealer’s hand and winning his bet. Thorp’s tens strategy, otherwise known as the hi-lo strategy, was a revolutionary breakthrough in card counting. While he could never be certain about which card would come next, he did know that statistically he had an edge according to one of the most fundamental rules in probability theory: the law of large numbers. The rule states that as a sample of random events, such as coin flips—or hands in a game of blackjack—increases, the expected average also becomes more certain.

**
Fortune's Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street
** by
William Poundstone

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Albert Einstein, anti-communist, asset allocation, beat the dealer, Benoit Mandelbrot, Black-Scholes formula, Brownian motion, buy low sell high, capital asset pricing model, Claude Shannon: information theory, computer age, correlation coefficient, diversified portfolio, Edward Thorp, en.wikipedia.org, Eugene Fama: efficient market hypothesis, high net worth, index fund, interest rate swap, Isaac Newton, Johann Wolfgang von Goethe, John Meriwether, John von Neumann, Kenneth Arrow, Long Term Capital Management, Louis Bachelier, margin call, market bubble, market fundamentalism, Marshall McLuhan, Myron Scholes, New Journalism, Norbert Wiener, offshore financial centre, Paul Samuelson, publish or perish, quantitative trading / quantitative ﬁnance, random walk, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, Ronald Reagan, Rubik’s Cube, short selling, speech recognition, statistical arbitrage, The Predators' Ball, The Wealth of Nations by Adam Smith, transaction costs, traveling salesman, value at risk, zero-coupon bond, zero-sum game

He was publishing learned articles with titles like “The Relation Between a Compact Linear Operator and Its Conjugate.” The publication for which he is best known came about by accident, though. In spring 1961, a book salesman visited MIT. Thorp found himself describing his blackjack system as a possible book. The salesman urged Thorp to submit an outline. He did. A small New York publisher called Blaisdell took the book. Released as Beat the Dealer in fall 1962, it became an instant classic of gambling literature. Blaisdell was gobbled up by Random House. Despite that apt name, the new corporate owner was reluctant to promote the book, judging it too mathematical. Even without much backing, the book made the best-seller lists. Thorp became a minor celebrity promoting the book. One TV talk show reunited him with a defiant Harold Smith, Jr.

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On a winter 1962 gambling trip, Thorp took along an expert on card cheating, Michael MacDougall, a former investigator for the Nevada Gambling Control Board. Thorp learned far more about cheating from MacDougall than he had from Kimmel. The two men spent six days in Las Vegas and two in Reno. MacDougall concluded that Thorp was not paranoid—everyone really was out to get him. Many of the dealers were second-dealing, the trick Kimmel had spotted in Reno. In the 1966 revision of Beat the Dealer, Thorp described a superior “point count” strategy. (Still popular today, this system is also known as “high-low.”) You count +1 for every low card you see played (2, 3, 4, 5, or 6) and -1 for every high card (10 or ace). This is easier than it sounds. High and low cards can be mentally paired off (and cancel out). This system is better than the ten-count at gauging deck conditions. A surprising conclusion of later computer studies, also reported in Thorp’s book, was that the Baldwin group had miscalculated the house advantage.

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Instead of the claimed 0.62 percent in favor of the house, it was about 0.10 percent in favor of the player. This is without counting cards. The Baldwin group’s basic strategy was not quite right, either. Thorp’s slightly improved strategy bumped up the advantage of the noncounting player to 0.13 percent. For years casinos had unknowingly offered a game that was favorable to the player. In Beat the Dealer, Thorp mentions his two financial backers only as “Mr. X” and “Mr. Y.” (Shannon makes a brief appearance as an unnamed “famous scientist.”) After the book’s success, Kimmel presented himself to friends as the true mastermind behind the book’s card-counting system. When fellow gambler Jack Newton called Kimmel’s bluff and asked why he had let Thorp write about his system, Kimmel replied, “Jack, I didn’t think it would be worth two cents.

pages: 360 words: 85,321

**
The Perfect Bet: How Science and Math Are Taking the Luck Out of Gambling
** by
Adam Kucharski

Ada Lovelace, Albert Einstein, Antoine Gombaud: Chevalier de Méré, beat the dealer, Benoit Mandelbrot, butterfly effect, call centre, Chance favours the prepared mind, Claude Shannon: information theory, collateralized debt obligation, correlation does not imply causation, diversification, Edward Lorenz: Chaos theory, Edward Thorp, Everything should be made as simple as possible, Flash crash, Gerolamo Cardano, Henri Poincaré, Hibernia Atlantic: Project Express, if you build it, they will come, invention of the telegraph, Isaac Newton, John Nash: game theory, John von Neumann, locking in a profit, Louis Pasteur, Nash equilibrium, Norbert Wiener, p-value, performance metric, Pierre-Simon Laplace, probability theory / Blaise Pascal / Pierre de Fermat, quantitative trading / quantitative ﬁnance, random walk, Richard Feynman, Richard Feynman, Ronald Reagan, Rubik’s Cube, statistical model, The Design of Experiments, Watson beat the top human players on Jeopardy!, zero-sum game

“Professional card counters are prohibited from playing at our tables.” It wasn’t a particularly effective deterrent. After reading the sign, only one thought came to mind: card counting works. It was the late 1970s, and casinos had spent the previous decade or so clamping down on a tactic they saw as cheating. Much of the blame—or perhaps credit—for the casinos’ losses goes to Edward Thorp. In 1962, Thorp published Beat the Dealer, which described a winning strategy for blackjack. Although Thorp has been called the father of card counting, the idea for a perfect blackjack strategy was actually born in a military barracks. Ten years before Thorp released his book, Private Roger Baldwin had been playing cards with fellow soldiers at the Aberdeen Proving Ground in Maryland. When one of the men suggested a game of blackjack, conversation turned to the rules of the game.

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Baldwin wouldn’t be able to do all the work by hand, so he asked Wilbert Cantey, a sergeant and fellow math graduate, if he could use the base’s calculator. Intrigued by Baldwin’s idea, Cantey agreed to help, as did James McDermott and Herbert Maisel, two other soldiers who worked in the analytics division. While Thorp was working on his roulette predictions in Los Angeles, the four men spent their evenings working out the best way to beat the dealer. After several months of calculations, they arrived at what they thought was the optimal strategy. But their perfect system didn’t turn out to be, well, perfect. “In statistical terms, we still had a negative expectation,” Maisel later said. “Unless you got lucky, you’d still lose in the long run.” Even so, by the group’s calculations they had managed to reduce the casino’s edge to a mere 0.6 percent.

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Although Thorp made money from blackjack, it wasn’t the main reason he made all those trips to Vegas. He saw it more as an academic obligation. When he’d first mentioned the existence of a winning strategy, the response wasn’t exactly positive. People ridiculed the idea, just as gamblers had done during his first attempt. After all, Thorp’s research challenged the widely held assumption that blackjack couldn’t be defeated. Beat the Dealer was Thorp’s way of proving that his theory was right. THAT SIGN IN ATLANTIC CITY always stuck with Bill Benter, so when he heard about Thorp’s book during a year studying abroad at Bristol University, he headed to the local library to get a copy. He had never seen anything so remarkable. “It showed that nothing was invulnerable,” he said. “Old maxims about the house always having the edge were no longer true.”

**
The Physics of Wall Street: A Brief History of Predicting the Unpredictable
** by
James Owen Weatherall

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Albert Einstein, algorithmic trading, Antoine Gombaud: Chevalier de Méré, Asian financial crisis, bank run, beat the dealer, Benoit Mandelbrot, Black Swan, Black-Scholes formula, Bonfire of the Vanities, Bretton Woods, Brownian motion, butterfly effect, capital asset pricing model, Carmen Reinhart, Claude Shannon: information theory, collateralized debt obligation, collective bargaining, dark matter, Edward Lorenz: Chaos theory, Edward Thorp, Emanuel Derman, Eugene Fama: efficient market hypothesis, financial innovation, fixed income, George Akerlof, Gerolamo Cardano, Henri Poincaré, invisible hand, Isaac Newton, iterative process, John Nash: game theory, Kenneth Rogoff, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, martingale, Myron Scholes, new economy, Paul Lévy, Paul Samuelson, prediction markets, probability theory / Blaise Pascal / Pierre de Fermat, quantitative trading / quantitative ﬁnance, random walk, Renaissance Technologies, risk-adjusted returns, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Coase, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, statistical arbitrage, statistical model, stochastic process, The Chicago School, The Myth of the Rational Market, tulip mania, V2 rocket, Vilfredo Pareto, volatility smile

The Physics of Wall Street: a brief history of predicting the unpredictable. 9781922072252 (e-book.) Includes bibliographical references. 1. Mathematical physics. 2. Finance. 3. Economics. 530.1 www.scribepublications.com.au To Cailin Contents Introduction: Of Quants and Other Demons 1 Primordial Seeds 2 Swimming Upstream 3 From Coastlines to Cotton Prices 4 Beating the Dealer 5 Physics Hits the Street 6 The Prediction Company 7 Tyranny of the Dragon King 8 A New Manhattan Project Epilogue: Send Physics, Math, and Money! Acknowledgments Notes References Introduction: Of Quants and Other Demons WARREN BUFFETT ISN’T the best money manager in the world. Neither is George Soros or Bill Gross. The world’s best money manager is a man you’ve probably never heard of — unless you’re a physicist, in which case you’d know his name immediately.

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Meanwhile, markets had changed, so that far more practitioners on Wall Street and elsewhere were equipped to understand and incorporate Mandelbrot’s ideas. It was at this point that the recognition of fat-tailed distributions reached the financial mainstream. But I am getting ahead of the story. It would take a blackjack sharp and a dilettantish ex-physicist to move finance to a place where it could take advantage of the insights of Bachelier, Osborne, and, ultimately, Mandelbrot. 4 Beating the Dealer THE YEAR IS 1961. The place, Las Vegas. It’s a Saturday night in the middle of June. The temperature is hovering around 100 degrees even though the sun has already set. Inside the casinos, no one cares. Vegas is at the height of its postwar golden age. A dozen world-class resorts, the first of their kind, line the nascent Strip, from the Sahara in the north to the Tropicana in the south.

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The game begins with each player (including the dealer) being dealt two cards, and then players have a chance to ask for additional cards until they decide they’ve had enough or they “bust,” which happens if their cards sum to more than twenty-one points. Number cards are worth their face value; face cards are worth ten points; and an ace can be worth either one point or eleven points, at the player’s discretion. The goal is to have the highest number of points without going over twenty-one. At a casino, each player is competing individually against the dealer, who represents the house. The goal, then, is to beat the dealer without busting. If you win, the game pays a dollar for every dollar you bet unless your initial two cards add up to twenty-one. In that case, the game pays a $1.50-per-dollar bet. Casinos always employ the same strategy. The dealer has to take a new card as long as his total number of points is less than seventeen. If it’s seventeen or more, the dealer stops. And if the dealer busts, everyone wins.

**
Dealers of Lightning
** by
Michael A. Hiltzik

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Apple II, Apple's 1984 Super Bowl advert, beat the dealer, Bill Duvall, Bill Gates: Altair 8800, computer age, creative destruction, Douglas Engelbart, Dynabook, Edward Thorp, El Camino Real, index card, Jeff Rulifson, John Markoff, Joseph Schumpeter, Marshall McLuhan, Menlo Park, oil shock, popular electronics, Robert Metcalfe, Ronald Reagan, Silicon Valley, speech recognition, Steve Ballmer, Steve Crocker, Steve Jobs, Steve Wozniak, Steven Levy, Stewart Brand, the medium is the message, Vannevar Bush, Whole Earth Catalog, zero-sum game

On the other hand, you can find a way for them to tell each other. The uncompromising give-and-take of Taylor’s ARPA contractor meetings lent itself to reproduction at PARC in the form of “Dealer.” The name derived from the book Beat the Dealer, by Edward O. Thorp, an MIT math professor who had developed a surefire system for winning at blackjack—“beating the dealer”—by counting the high-and low-value cards dealt out in hands. (This truly effective system would make the unassuming Ed Thorp the godfather of professional blackjack card-counting.) Taylor was not much of a blackjack buff. What interested him about Beat the Dealer was its compelling metaphor of a doughty individual fielding the challenge of a group of trained and determined adversaries. In casino blackjack the dealer plays against everyone at the table. In Taylor’s variant a single researcher would propose an idea or project, then stand alone to defend it against dissection by his peers.

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DEALERS OF LIGHTNING Xerox PARC and the Dawn of the Computer Age Michael Hiltzik To Deborah, Andrew, and David Contents Cast of Characters v Timeline ix Introduction The Time Machine xv Part I: Prodigies 1 Chapter 1 The Impresario 3 Chapter 2 McColough’s Folly 21 Chapter 3 The House on Porter Drive 33 Chapter 4 Utopia 52 Chapter 5 Berkeley’s Second System 68 Chapter 6 “Not Your Normal Person” 80 Chapter 7 The Clone 97 Chapter 8 The Future Invented 117 Part II: Inventors 125 Chapter 9 The Refugee 127 Chapter 10 Beating the Dealer 145 Chapter 11 Spacewar 155 Chapter 12 Thacker’s Bet 163 Chapter 13 The Bobbsey Twins Build a Network 178 Chapter 14 What You See Is What You Get 194 Chapter 15 On the Lunatic Fringe 211 Chapter 16 The Pariahs 229 Chapter 17 The Big Machine 242 Part III: Messengers 257 Chapter 18 Futures Day 259 Chapter 19 Future Plus One 274 Chapter 20 The Worm That Ate the Ethernet 289 Chapter 21 The Silicon Revolution 300 Chapter 22 The Crisis of Biggerism 314 Chapter 23 Steve Jobs Gets His Show and Tell 329 Chapter 24 Supernova 346 Chapter 25 Blindsided 361 Chapter 26 Exit the Impresario 371 Epilogue Did Xerox Blow It?

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Even so, for the white-light copier engineers of Webster the laser printer never shed the frightening aspect of an alien technology. “Years afterwards I went back there,” Starkweather said. “I ran into my old boss, the one who had tried to keep me from leaving. His last words to me were, ‘Are you still playing around with that laser stuff?’ “By then the laser printer was a $2 billion-a-year business.” CHAPTER 10 Beating the Dealer Chris Jeffers took a deep breath before walking into the big corner conference room on Porter Drive. Alan Kay, who had recruited his childhood friend to join PARC as a sort of amanuensis and chief of staff, had guided him through the rigorous interview process and as far as this last hurdle, the delivering of a technical presentation to his future colleagues sitting in a sort of plenary session.

**
Bringing Down the House: The Inside Story of Six M.I.T. Students Who Took Vegas for Millions
** by
Ben Mezrich

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airport security, beat the dealer, Edward Thorp, Silicon Valley, upwardly mobile, white picket fence

The player went first, the dealer second. The dealer’s play depended on the casino, but usually he would hit until his cards added up to seventeen—or until he busted. When you got pairs of the same card, you could split them and have two bets going on separate hands. Again depending on the casino, you could double your bet—double down—on your first two cards, taking a single card in the hopes of beating the dealer for more money. The rules were fairly simple, as card games went. But the strategy seemed tricky, and Kevin was by no means an expert. “I know the books say you’re supposed to keep on hitting until you get seventeen, if the dealer’s showing a high card. When the dealer shows a weak card—maybe a five or a six—you usually stick with your first two cards. And I know you double down on an eleven, hoping to draw a face card for a twenty-one.”

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The suited man looked over, seemed to recognize Fisher, then nodded. He’d seen enough of Fisher’s play to know that he wasn’t a threat.Another rich kid doing something stupid. The dealer dealt the first card to Fisher—and there it was, an ace of spades. The two women crowed, jabbering about the crazy fool’s luck. The rest of the cards came out: Fisher’s second card was a nine, for a soft twenty, beating the dealer’s seventeen. Fisher swept up his winnings and stood, smiling at the two women. “Thank you for your help. I think I’m finally starting to get the hang of it.” Then he walked right past Kevin and Martinez and headed for the pool. They found him stretched out on a lounge chair, hands behind his head. His dark eyes were shielded by wraparound sunglasses, and his biceps bulged beneath a tight white T-shirt.

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Are you familiar with the practice?” Kevin nodded. “I’ve done a bit of reading on the subject.” “Good, good. So you must have heard of the hi-lo method of counting, right?” Kevin nodded again. His memory wasn’t photographic like some other MIT kids he knew, but he retained things fairly well. He knew that the hi-lo method dated back to 1962 and the publication of Edward Thorp’s groundbreaking best-seller Beat the Dealer. In the book, Thorp outlined a simple counting method that allowed players to keep rough track of the number of high cards left in an unplayed shoe. Instead of counting individual cards, players simply kept track of a single number, the running count. This number was added to every time a low card came out of the deck, and subtracted from every time a high card hit the table. The more positive the running count, the more high cards were left in the deck—giving the player an advantage and inciting him to raise his bet.

**
Beat the Market
** by
Edward Thorp

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beat the dealer, compound rate of return, Edward Thorp, margin call, Paul Samuelson, RAND corporation, short selling, transaction costs

Other books by EDWARD O. THORP Elementary Probability Beat the Dealer Other books by SHEEN T. KASSOUF Evaluation of Convertible Securities A Theory and an Econometric Model for Common Stock Purchase Warrants BEAT THE MARKET A scientific Stock Market System Random House New York BEAT THE MARKET A Scientific Stock Market System Edward O. Thorp, Ph.D. Professor of Mathematics University of California at Irvine Sheen T. Kassouf, Ph.D. Assistant Professor of Economics University of California at Irvine 987 © Copyright, 1967, by E. O. Thorp and S. T. Kassouf All rights reserved under International and Pan-American Copyright Conventions. Published in New York by Random House, Inc., and simultaneously in Toronto, Canada, by Random House of Canada Limited. Library of Congress Catalog Card Number: 67:22624 Manufactured in the United States of America Designed by Betty Anderson Contents INTRODUCTION 3 Chapter 1 A SYSTEM IS BORN 7 First venture into the market.

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Highly mathematical. 210 [16] Securities and Exchange Commission, Report of Special Study of Securities Markets, Part 2. 88th Congress, 1st Session, House Document No. 95, Pt. 2. [17] Shultz, Birl E., The Securities Market and How It Works. Revised. Ed. by Albert P. Squier. Harper and Row, New York, 1963. A standard text on the mechanics of investing. [18] Skelly, William S., Convertible Bonds: A Study of Their Suitability for Commerical Bank Bond Portfolios. Salomon Bros. and Hutzler, New York, 1959. The role convertible bonds can play in a bank’s portfolio. [19] Thorp, Edward O., Beat the Dealer. Revised. Random House, New York, 1966. The best seller which presents a winning strategy for the casino game of blackjack, or twenty-one. Includes anecdotes and experiences of the author and an account of unsuccessful attempts by casinos to change their rules. [20] Von Neumann, John and Morgenstern, Oskar, Theory of Games and Economic Behavior. Wiley (Science Editions), 1964. The seminal work on game theory by a mathematician and an economist.

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., 101 Wall Street Journal, 26, 53, 71, 104, 109, 128, 162, 166 Warrant axis, 21 Warrant hedge, 43fn Warrant prices, effect of common on, 18-22 effect of short position on, 129 prediction of, 201, 204 sources of, 107fn Warrant terms, sources for, 107fn Warrants, 15 adjusted, 24-26 attached to bond, 98 best, 77, 79 Canadian, 103, 106, 107, 200-203 choosing warrant situations, 88-89 definition, 15 effect of dilution, 110-111 effect of dividend, 110-111 effect of past price history, 111 exercise price, 16 expiration date, 16 extension of conversion privilege, 137-138 gain from short sales, 37 latent, 145 not traded on NYSE, 71 over-the-counter, 103, 106-107, 201 perpetual, 16 premium, 28 profits from shorting, 37 regional, 103 short selling, 36-39 tables of, 29, 202-203 tax advantage in issuing, 98 terms of, 72 why issued, 16 Warrant-stock diagram, applied, 73-77 construction of, 18-22 “corner,” 151 explained, 18ff zero-profit lines in, 47-49 Western Decalta, 203 Weston (George) Ltd., 107 Where Are the Customers’ Yachts?, 161 White Oil Company, 99 Writer, option, 164 definition, 162 Yield, current, 144 to maturity, 144 Xerox 4s of ‘84, 156-158 Zero-profit line, 80 explained, 47 how to draw, 48, 81 with reverse hedge, 124 Yearly range, 119 ABOUT THE AUTHORS EDWARD O. THORP is the author of the best-seller Beat the Dealer: A Winning Strategy for the Game of TwentyOne, published by Random House in 1962 and in revised form in 1966. It presented the first scientific winning system ever devised for a major casino gambling game. He has also written Elementary Probability (1966) and numerous mathematical papers on probability, game theory, and functional analysis. He completed undergraduate and graduate work at U.C.L.A., receiving the B.A. and M.A. in physics, and the Ph.D. in mathematics in 1958.

**
Alex's Adventures in Numberland
** by
Alex Bellos

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Andrew Wiles, Antoine Gombaud: Chevalier de Méré, beat the dealer, Black Swan, Black-Scholes formula, Claude Shannon: information theory, computer age, Daniel Kahneman / Amos Tversky, Edward Thorp, family office, forensic accounting, game design, Georg Cantor, Henri Poincaré, Isaac Newton, Myron Scholes, pattern recognition, Paul Erdős, Pierre-Simon Laplace, probability theory / Blaise Pascal / Pierre de Fermat, random walk, Richard Feynman, Richard Feynman, Rubik’s Cube, SETI@home, Steve Jobs, The Bell Curve by Richard Herrnstein and Charles Murray, traveling salesman

‘I think the consensus after decades of examining this question,’ he replied, ‘is that the betting strategies may be two thirds or three quarters of what you’re going to get out of it, and playing strategy is maybe a third to a quarter. So, the betting strategy is much more important.’ Kelly’s strategy would later help Thorp make more than $80 billion dollars on the financial markets. Ed Thorp announced his card-counting system in his 1962 book Beat the Dealer. He refined the method for a second edition in 1966 that also counted the cards worth ten (the jack, queen, king and ten). Even though the ten cards shift the odds less than the five do, there are more of them, so it’s easier to identify advantages. Beat the Dealer sold more than a million copies, inspiring – and continuing to inspire – legions of gamblers. In order to eliminate the threat of card-counting, casinos have tried various tactics. The most common was to introduce multiple decks because with more cards, counting is made both more difficult and less profitable.

…

‘The family went on a trip to the World’s Fair in Spokane and on the way back we stopped at Harrah’s [casino] and I told my kids to give me a couple of hours because I wanted to pay for the trip – which I did.’ Beat the Dealer is not just a gambling classic. It also reverberated through the worlds of economics and finance. A generation of mathematicians inspired by Thorp’s book began to create models of the financial markets and apply betting strategies to them. Two of them, Fischer Black and Myron Scholes, created the Black-Scholes formula indicating how to price financial derivatives – Wall Street’s most famous (and infamous) equation. Thorp ushered in an era when the quantitative analyst, the ‘quant’ – the name given to the mathematicians relied on by banks to find clever ways of investing – was king. ‘Beat the Dealer was kind of the first quant book out there and it led fairly directly to quite a revolution,’ said Thorp, who can claim – with some justification – to being the first-ever quant.

…

., Taking Chances, Oxford University Press, Oxford, 1999 Kaplan, M., and Kaplan, E., Chances Are, Penguin, New York, 2006 Mlodinow, L., The Drunkard’s Walk, Allen Lane, London, 2008 Paulos, J.A., Innumeracy, Hill & Wang, New York, 1988 Poundstone, W., Fortune’s Formula, Hill & Wang, New York, 2005 Rosenthal, J.S., Struck by Lightning, Joseph Henry Press, Washington DC, 2001 Thorp, E.O., Beat the Dealer, Vintage, New York, 1966 Tijms, H., Understanding Probability, Cambridge University Press, 2007 Venn, J., The Logic of Chance, Macmillan, London, 1888 CHAPTER TEN Statistics is the one field of maths covered in this book that I never studied at school or college, so much of this was very new to me. Some mathematicians don’t even consider statistics proper maths, occupied as it is with messy things like measurement.

**
Quantitative Value: A Practitioner's Guide to Automating Intelligent Investment and Eliminating Behavioral Errors
** by
Wesley R. Gray,
Tobias E. Carlisle

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activist fund / activist shareholder / activist investor, Albert Einstein, Andrei Shleifer, asset allocation, Atul Gawande, backtesting, beat the dealer, Black Swan, capital asset pricing model, Checklist Manifesto, cognitive bias, compound rate of return, corporate governance, correlation coefficient, credit crunch, Daniel Kahneman / Amos Tversky, discounted cash flows, Edward Thorp, Eugene Fama: efficient market hypothesis, forensic accounting, hindsight bias, intangible asset, Louis Bachelier, p-value, passive investing, performance metric, quantitative hedge fund, random walk, Richard Thaler, risk-adjusted returns, Robert Shiller, Robert Shiller, shareholder value, Sharpe ratio, short selling, statistical model, survivorship bias, systematic trading, The Myth of the Rational Market, time value of money, transaction costs

The stock market also is a game of imperfect information and even resembles bridge in that they both have their deceptions and swindles. Like bridge, you do better in the market if you get more information, sooner, and put it to better use. It's no surprise then that Buffett, arguably the greatest investor in history, is a bridge addict. Thorp was no stranger to the card table either. Before he figured out how to beat the market, Thorp wrote Beat the Dealer, the definitive book on blackjack card counting. William Poundstone recounts the story of Thorp's foray into card counting in his book, Fortune's Formula.6 In 1958, Thorp had read an article by mathematician Roger Baldwin, who had used U.S. Army “computers”—which actually meant “adding machines” or the people who operated them—to calculate the odds of various blackjack strategies in an effort to find an optimal strategy.

…

Thorp realized that by simply keeping track of the five cards, the player could determine the favorability or otherwise of the cards remaining in the deck. Thorp found that his improved strategy gave the player an edge of 0.13 percent. That small edge, Thorp reasoned, given enough hands, could add up to a lot of money. He published his new strategy first in a paper and then subsequently as Beat the Dealer in 1962, which went on to become a classic in gambling literature. The book detailed how Thorp had used his card-counting strategy for a period of several years, making $25,000 in the process. The casinos didn't like players counting cards to gain an edge. They immediately started taking “counter-measures,” including adding more decks, randomly shuffling the cards, using “mechanics” (dealers who cheated by manipulating the cards in the deck), threatening Thorp with physical harm, and then simply barring him from the casinos.

…

A blog about recent developments in quantitative value investing. Index Accruals detecting earnings manipulation Activism and cloning Adjustment bias Alpha and adjusted performance sustainable Altman, Edward I. Analysis legend Anchoring Anderson, Keith Apple Inc. Availability bias Ayres, Ian Bachelier, Louis Bailey, Morris Bankruptcy prediction history of improving Batchelor, Roy Beat the Dealer (Thorp) Beat the Market: A Scientific Stock Market System (Thorp & Kassouf) Behavioral errors, quantitative investing's protection against cognitive biases experts' errors value investors'errors Behavioral Investing: A Practitioners Guide to Applying Behavioral Finance (Montier) Benchmarking Beneish, Messod Berk, Jonathan Bogue, Marcus Bonaime, Alice Book value-to-market capitalization ratio Brooks, Chris Buffett, Warren See's Candies acquisition Buybacks Campbell, John Cash flow on assets (CFOA) CGM Focus Fund Chava, Sudheer “The Checklist” (Gawande) The Checklist Manifesto: How to Get Things Right (Gawande) Chuvakhin, Nikolai Cloning Cognitive biases adjustment bias anchoring availability bias hindsight bias neglect of the base case overconfidence self-attribution bias Confirmation bias “Contrarian Investment, Extrapolation, and Risk” (Lakonishok, Schleifer, & Vishny) Cowles, Alfred, III “The Cross-Section of Expected Stock Returns” (Fama & French) Data mining “Decoding Inside Information” (Cohen, Malloy, & Pomorski) “Delisting Returns and Their Effect on Accounting-Based Market Anomalies” (Price, Beaver, & McNichols) Dumb money, paradox of behavioral errors, quantitative investing's protection against cognitive biases experts' errors value investors'errors quantitative value investing, power of value strategies Graham's quantitative Earnings manipulators and frauds, eliminating accruals detecting earnings manipulation PROBMs, predicting Enron Earnings yield Efficient market theory Einhorn, David Enron Enterprise yield (EBITDA and EBIT variations) Expert Political Judgment (Tetlock) Fama, Eugene Financial distress, measuring risk of bankruptcy prediction history of improving calculating universe, scrubbing Financial strength case study: Lubrizol Corporation comparing performance of F_SCORE and FS_SCORE financial strength score (FS_SCORE) current profitability formula and interpretation recent operational improvements stability Piotroski Fundamental Score (F_SCORE) analyzing formula and interpretation Fooled by Randomness (Taleb) Forward earnings estimate Franchises finding economic moats and excess returns persistence pricing power and big, stable margins See's Candies, acquisition by Buffett Fraud.

**
Hedge Fund Market Wizards
** by
Jack D. Schwager

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asset-backed security, backtesting, banking crisis, barriers to entry, beat the dealer, Bernie Madoff, Black-Scholes formula, British Empire, Claude Shannon: information theory, cloud computing, collateralized debt obligation, commodity trading advisor, computerized trading, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, delta neutral, diversification, diversified portfolio, Edward Thorp, family office, financial independence, fixed income, Flash crash, hindsight bias, implied volatility, index fund, intangible asset, James Dyson, Long Term Capital Management, margin call, market bubble, market fundamentalism, merger arbitrage, money market fund, oil shock, pattern recognition, pets.com, Ponzi scheme, private sector deleveraging, quantitative easing, quantitative trading / quantitative ﬁnance, Right to Buy, risk tolerance, risk-adjusted returns, risk/return, riskless arbitrage, Rubik’s Cube, Sharpe ratio, short selling, statistical arbitrage, Steve Jobs, systematic trading, technology bubble, transaction costs, value at risk, yield curve

In fact, it is the difficulty in beating the market (the vast majority of market participants fail to do so) that helps create the illusion that markets are efficient. Thorp’s career encompasses an extraordinary number of first achievements: He co-developed (along with Claude Shannon) the first wearable computer that could be used to win at roulette. He developed the first blackjack betting strategy that provided a positive edge to the player, which he divulged in his global best seller, Beat the Dealer. The book changed the way casinos operate. Thorp along with Sheen Kassouf developed the first known systematic approach to trading warrants and other convertible securities (e.g., options, convertible bonds, convertible preferred stocks) by hedging them with offsetting stock positions, an approach they detailed in their book, Beat the Market.3 He was the first to formulate an option-pricing model that was equivalent to the Black-Scholes model.

…

But at that point, the ideas were already out there, so “taking care of you,” wouldn’t have done anything for them anyway. It would have been useless, and they realized that. Some years ago, I read a book called Eudaemonic Pie about a group of physics students who also developed a shoe computer using Newtonian physics to predict the most likely outcome for roulette spins. Was there any connection between you and them? Here is the connection. In the second edition of Beat the Dealer, I mentioned there was a way to win at roulette. In 1969, I got a call from a mathematician named Ralph Abraham inquiring about a roulette system. At that time, I thought that I would never use it myself again, so I might as well let the information out. Within a few years, some physics graduate students did the same thing. They had the next generation of electronics and arrived at the same 44 percent edge.

…

He came into the house and introduced the young ladies as his nieces. My wife, Vivian, looked at them suspiciously. I guess she wasn’t buying the niece story. Vivian was much more perceptive, but I was willing to accept it at face value. Kimmel asked me a lot of questions about blackjack and then asked me to demonstrate the system. After a couple of hours, he decided to go ahead. After your book Beat the Dealer, which revealed your blackjack system to the public, was published and became a best seller, were the casinos beginning to lose money as a result? What happened was this: There were a number of really good players, maybe a thousand or so, who extracted money from the casinos. Then there was a much larger number of players who used the basic strategy, so they could play much longer without losing as much.

**
Frequently Asked Questions in Quantitative Finance
** by
Paul Wilmott

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Albert Einstein, asset allocation, beat the dealer, Black-Scholes formula, Brownian motion, butterfly effect, capital asset pricing model, collateralized debt obligation, Credit Default Swap, credit default swaps / collateralized debt obligations, delta neutral, discrete time, diversified portfolio, Edward Thorp, Emanuel Derman, Eugene Fama: efficient market hypothesis, fixed income, fudge factor, implied volatility, incomplete markets, interest rate derivative, interest rate swap, iterative process, London Interbank Offered Rate, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, margin call, market bubble, martingale, Myron Scholes, Norbert Wiener, Paul Samuelson, quantitative trading / quantitative ﬁnance, random walk, regulatory arbitrage, risk/return, Sharpe ratio, statistical arbitrage, statistical model, stochastic process, stochastic volatility, transaction costs, urban planning, value at risk, volatility arbitrage, volatility smile, Wiener process, yield curve, zero-coupon bond

See Sobol’ (1967), Faure (1969), Hammersley and Handscomb (1964), Haselgrove (1961) and Halton (1960). Figure 1-1: They may not look like it, but these dots are distributed deterministically so as to have very useful properties. 1968 Thorp Ed Thorp’s first claim to fame was that he figured out how to win at casino Blackjack, ideas that were put into practice by Thorp himself and written about in his best-selling Beat the Dealer, the “book that made Las Vegas change its rules.” His second claim to fame is that he invented and built, with Claude Shannon, the information theorist, the world’s first wearable computer. His third claim to fame is that he was the first to use the ‘correct’ formulæ for pricing options, formulæ that were rediscovered and originally published several years later by the next three people on our list.

…

Prentice-Hall Sloan, IH & Walsh, L 1990 A computer search of rank two lattice rules for multidimensional quadrature. Mathematics of Computation 54 281-302 Sobol’, IM 1967 On the distribution of points in cube and the approximate evaluation of integrals. USSR Comp. Maths and Math. Phys. 7 86-112 Stachel, J (ed.) 1990 The Collected Papers of Albert Einstein. Princeton University Press Thorp, EO 1962 Beat the Dealer. Vintage Thorp, EO & Kassouf, S 1967 Beat the Market. Random House Thorp, EO 2002 Wilmott magazine, various papers Traub, JF & Wozniakowski, H 1994 Breaking intractability. Scientific American Jan 102-107 Vasicek, OA 1977 An equilibrium characterization of the term structure. Journal of Financial Economics 5 177-188 Wiener, N 1923 Differential space. J. Math. and Phys. 58 131-74 Chapter 2 FAQs What are the Different Types of Mathematics Found in Quantitative Finance?

**
Red-Blooded Risk: The Secret History of Wall Street
** by
Aaron Brown,
Eric Kim

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activist fund / activist shareholder / activist investor, Albert Einstein, algorithmic trading, Asian financial crisis, Atul Gawande, backtesting, Basel III, Bayesian statistics, beat the dealer, Benoit Mandelbrot, Bernie Madoff, Black Swan, capital asset pricing model, central bank independence, Checklist Manifesto, corporate governance, creative destruction, credit crunch, Credit Default Swap, disintermediation, distributed generation, diversification, diversified portfolio, Edward Thorp, Emanuel Derman, Eugene Fama: efficient market hypothesis, experimental subject, financial innovation, illegal immigration, implied volatility, index fund, Long Term Capital Management, loss aversion, margin call, market clearing, market fundamentalism, market microstructure, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, Myron Scholes, natural language processing, open economy, Pierre-Simon Laplace, pre–internet, quantitative trading / quantitative ﬁnance, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, road to serfdom, Robert Shiller, Robert Shiller, shareholder value, Sharpe ratio, special drawing rights, statistical arbitrage, stochastic volatility, The Myth of the Rational Market, Thomas Bayes, too big to fail, transaction costs, value at risk, yield curve

Quants to Wall Street A lot of gambling quants moved to Wall Street in the early 1980s, representing maybe 20 of the 100 or so rocket scientists who arrived around the same time. Other rocket scientists had been floor traders or other kinds of risk takers. What we had in common were quantitative training, a similar view of the world, similar aspirations, and at least several years of experience supporting ourselves with independent risk-taking activities. We also had in common a few books, first among which were Edward Thorp’s Beat the Dealer (Random House, 1962) and Beat the Market (Random House, 1967), the latter written with Sheen Kassouf. Ed was the mathematics professor who analyzed and popularized blackjack card counting, and also beat the house at other casino games. In the mid-1960s he turned to investing and invented or perfected an extraordinary number of what are now the standard hedge fund strategies. In addition, he is crucially important as the first person to expand upon and popularize the work of John Kelly (whose work was the basis of risk ignition, as explained in Chapter 3).

…

Index Accuracy ratio Adams, Brandon Aggregation process Ainsley, Craig Algorithmic Trading and DMA ( Johnson) Algren, Nelson All the Devils Are Here (McLean and Nocera) Allen, Franklin Anderson, Chris Anomalies Anthropology of Economy, The (Gudeman) Arbitrage Ariely, Dan Ars Conjectandi (Bernoulli) Augar, Philip Autocorrelation Bacharach, Michael Back office Backward-looking risk management Bad-boy publicity Bad Bet (O’Brien) Bankers Trust Bank for International Settlements Bank One Barter, Exchange and Value (Humphrey and Hugh-Jones) Basel capital rules Bayes, Thomas Bayesians/Bayesian concepts. See also Probability betting/probability and foundation of frequentism and in history/law “prior beliefs” and risk defining capital technology startups and Beat the Dealer (Thorp) Beat the Market (Thorp and Kassouf) Behavioral Game Theory (Camerer) Bennet, Rick Bernoulli, Jakob Berns, Gregory Bernstein, Peter Betting: Kelly bets probability and public sports Beyond Counting (Grosjean) Beyond Individual Choice (Bacharach) Big Short, The (Lewis) Black, Alethea Black, Fischer Black-Scholes-Merton model Black Swan, The (Taleb) Black Wednesday Bloom, Murray Teigh Bogle, John Bond ratings Bookstaber, Richard Born Losers (Sandage) Bounds of Reason, The (Gintis) Brenner, Reuven and Gabrielle Bringing Down the House (Mezrich) British Treasury Broke, (Adams) Bronze Age Bronze Age Economics (Earle) Bubble investors Bulls, Bears, and Brains (Leitzes) Burton, Robert Alan Business Cycles and Equilibrium (Black) Busting Vegas (Mezrich) Calvet, Laurent E.

**
Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives
** by
Satyajit Das

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accounting loophole / creative accounting, Albert Einstein, Asian financial crisis, asset-backed security, beat the dealer, Black Swan, Black-Scholes formula, Bretton Woods, BRICs, Brownian motion, business process, buy low sell high, call centre, capital asset pricing model, collateralized debt obligation, commoditize, complexity theory, computerized trading, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, cuban missile crisis, currency peg, disintermediation, diversification, diversified portfolio, Edward Thorp, Eugene Fama: efficient market hypothesis, Everything should be made as simple as possible, financial innovation, fixed income, Haight Ashbury, high net worth, implied volatility, index arbitrage, index card, index fund, interest rate derivative, interest rate swap, Isaac Newton, job satisfaction, John Meriwether, locking in a profit, Long Term Capital Management, mandelbrot fractal, margin call, market bubble, Marshall McLuhan, mass affluent, mega-rich, merger arbitrage, Mexican peso crisis / tequila crisis, money market fund, moral hazard, mutually assured destruction, Myron Scholes, new economy, New Journalism, Nick Leeson, offshore financial centre, oil shock, Parkinson's law, placebo effect, Ponzi scheme, purchasing power parity, quantitative trading / quantitative ﬁnance, random walk, regulatory arbitrage, Right to Buy, risk-adjusted returns, risk/return, Satyajit Das, shareholder value, short selling, South Sea Bubble, statistical model, technology bubble, the medium is the message, the new new thing, time value of money, too big to fail, transaction costs, value at risk, Vanguard fund, volatility smile, yield curve, Yogi Berra, zero-coupon bond

This necessitated the extensive restructuring of Ashanti, including the sale of a key Tanzanian mine, dilution of its equity shareholders and the restructuring of its hedge positions. Banks fête many companies as ‘sophisticated’ hedgers. There are flattering profiles in financial magazines about their operations. All that the accolades say is that the companies have provided a lot of business and profits for the banks. ‘Zaiteku’ or the bride stripped bare Having mastered the business of hedging, corporations rapidly moved on to trying to beat the dealers at their own game: trading. In 1991, Allied Lyons (now known as Allied Domecq), a British food and drinks company, lost Having mastered the £150 million in currency option trading. business of hedging, Instead of hedging the company’s risk, its corporations rapidly moved treasury tried to make profits trading in currency options. Led by an ex-banker, the on to trading. Allied Lyons treasury team tried ‘to make a difference to the company’s bottom line’.

…

So the convertible did convert after all, there just wasn’t any blue sky – it was the dark abyss below. So, who was fooling whom? Strippers You can strip down cars. It’s the same with convertibles. Convertible stripping dates back to the 1960s. A famous 1967 book by Edward Thorp and Sheen Kassouf, Beat the Market, set out the principles of convertible arbitrage. Thorp was already well known for another book, Beat the Dealer, which set out the process of card counting in blackjack. Thorp and Kassouf outlined the idea of breaking up a convertible bond into its bond and equity parts and hedging and trading them separately. Astute traders began buying convertible bonds and stripping them. They sold the equity option to someone who wanted the equity and the bond without the option to an investor who just wanted the debt.

**
Stock Market Wizards: Interviews With America's Top Stock Traders
** by
Jack D. Schwager

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Asian financial crisis, banking crisis, barriers to entry, beat the dealer, Black-Scholes formula, commodity trading advisor, computer vision, East Village, Edward Thorp, financial independence, fixed income, implied volatility, index fund, Jeff Bezos, John Meriwether, John von Neumann, locking in a profit, Long Term Capital Management, margin call, money market fund, Myron Scholes, paper trading, passive investing, pattern recognition, random walk, risk tolerance, risk-adjusted returns, short selling, Silicon Valley, statistical arbitrage, the scientific method, transaction costs, Y2K

But there are a few successful quantitative traders who from time to time publish useful information, even when it may not be in their own selfinterest to do so. My favorite example is Ed Thorpe, who was a real pioneer in the field. He was doing this stuff well before almost anyone else. Ed has been remarkably open about some of the money-making strategies he's discovered over the years, both within and outside of the field of finance. After he figured out how to beat the casinos at blackjack, he published Beat the Dealer. Then when he figured out how to beat the market, he published Beat the Market, which explained with his usual professorial clarity exactly how to take advantage of certain demonstrable market inefficiencies that existed at the time. Of course, the publication of his book helped to eliminate those very inefficiencies. In the case of blackjack, does eliminating the inefficiencies mean that the casinos went to the use of multiple decks?

…

INDEX accounting, 84, 89, 91, 94, 324 Blake, Gil, 189, 197-98 Bloomberg financial services, 57, 59 acquisition finance, 250-52, 253 Advanced Research Projects Agency (ARPA), 262 AIDS drugs, 1 74 Amazon.com, 150-52, 272-73, 323 America Online (AOL), 43-44, 235, 259 Amerigon, 62 arbitrage, 132-33, 255-56, 267, 284 ARPAnet, 262 Asian financial crisis, 18 assets: growth of, 23-24, 207, 312-13 liquidation of, ]65 return of, ], 31 transfer of, 189 value of, 41, 63, 248-49, 253 audits, 84,91 Balance Bars, 66 balance sheets, 42, 51, 85, 268 Bankers Trust, 57, 58 banking, 141, 243-44, 249 Bombay (clothing store), 67-68 bonds: convertible, 257 government, 8, 247-48 illiquid, 7, 8, 25 interest rates and, 9, 24, 67, 105, 133-34, 135, 269, 277 junk, 82 market for, 9-10, 1 10-1 1, 144-45, 285, 309 price of, 7-8, 110-11, 144-45, 285 book value, 44, 149, 150, 165, 167 Brandywine Fund, 58-59 brokerage firms, 55-56, 61-62 Buffett, Warren, 40, 42, 157 business plans, 68-69, 91, 94, 1 18, 122, 316, 324 Business Week, \27n Canada, 1-6, 9-10, 36 capital: bankruptcy, 12-14, 24, 105-6, 122, 139, 145-46, appreciation of, 23 loss of, 68 163 Bannister, Roger, 291 Bear Stearns, 127, 131, 135-36, 138, 142 Beat the Dealer (Thorpe), 266 Beat the Market (Thorpe), 266 Bender, John, 221-38 background of, 221-25 fund managed by, 221, 222 losses of, 225 as novice trader, 225-27 profits of, 221-22, 234 strategy of, 221, 226-38, 303, 304, 306, 312 Bezos, Jeff, 272-73 preservation of, 44, 141, 217 venture, 10, 205, 207, 222, 303 capitalization: large, 34, 43-44, 150, 198-99, 320 medium, 58 revenue vs., 36-37, 45, 52 small, 24, 47, 57, 58, 59, 68, 69, 78, 198-99, 281 for trading, 10, 114-19, 120, 142, 146, 147,205, 207, 222, 303 cash flow, 43, 44, 45, 51, 149, 248 catalysts, 44-46, 52, 60, 61, 62-63, 89, 94, 114, bid/ask differentials, 134-35 215-17,220, 279-81, 307, 325 Black & Decker, 62-63 central processing unit (CPU), 261 blackjack, 266-67 Black-Scholes model, 221, 227-34 certificates, stock, 69-70 chart patterns, 181-84 331 INDEX chief executive officers (CEOs), 49, 91, 241, 244-45, 250 Cook, Marvin, 95, 96, 123-24, 126 Cook, Terri, 97, 99, 106 funds managed by, 128-29, 138, 142-47 Ingram's, 272 as novice trader, 127-38 initial public offerings (IPOs), 24, 25, 250-52, chief financial officers (CFOs), 57, 58, 59, 60, 62, 64, Cramer's commentary, 218 67, 71, 72,94, 142, 324 Church, George J., 320 Cisco, 22 Cray, Seymour, 261-62 profits of, 128-29, 132, 141-42, 147 strategy of, 138-47, 252, 300, 301, 304, 305, 306 279-81 innovation, 147 currency trading, 5, 9, 202-3 Cyrus J.

**
The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street
** by
Justin Fox

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activist fund / activist shareholder / activist investor, Albert Einstein, Andrei Shleifer, asset allocation, asset-backed security, bank run, beat the dealer, Benoit Mandelbrot, Black-Scholes formula, Bretton Woods, Brownian motion, capital asset pricing model, card file, Cass Sunstein, collateralized debt obligation, complexity theory, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, discovery of the americas, diversification, diversified portfolio, Edward Glaeser, Edward Thorp, endowment effect, Eugene Fama: efficient market hypothesis, experimental economics, financial innovation, Financial Instability Hypothesis, fixed income, floating exchange rates, George Akerlof, Henri Poincaré, Hyman Minsky, implied volatility, impulse control, index arbitrage, index card, index fund, information asymmetry, invisible hand, Isaac Newton, John Meriwether, John Nash: game theory, John von Neumann, joint-stock company, Joseph Schumpeter, Kenneth Arrow, libertarian paternalism, linear programming, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, market bubble, market design, Myron Scholes, New Journalism, Nikolai Kondratiev, Paul Lévy, Paul Samuelson, pension reform, performance metric, Ponzi scheme, prediction markets, pushing on a string, quantitative trading / quantitative ﬁnance, Ralph Nader, RAND corporation, random walk, Richard Thaler, risk/return, road to serfdom, Robert Bork, Robert Shiller, Robert Shiller, rolodex, Ronald Reagan, shareholder value, Sharpe ratio, short selling, side project, Silicon Valley, South Sea Bubble, statistical model, The Chicago School, The Myth of the Rational Market, The Predators' Ball, the scientific method, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Kuhn: the structure of scientific revolutions, Thomas L Friedman, Thorstein Veblen, Tobin tax, transaction costs, tulip mania, value at risk, Vanguard fund, Vilfredo Pareto, volatility smile, Yogi Berra

He accepted the offer of a pair of New York area businessmen—one of them Emmanuel Kimmel, whose New Jersey parking-garage business would later grow into entertainment giant Time Warner.3 Kimmel flew Thorp to New York several Wednesdays in a row to practice the scheme, sending him back up to Boston each time, Thorp recalled, with a reward of $100 in cash and a salami. During MIT’s spring break, Thorp and his new partners traveled to Reno to try out his method. It worked, and Thorp wrote a book about it called Beat the Dealer, which became a bestseller and made the professor a minor celebrity. The book, still in print, continues to inspire new generations of card sharps (the MIT students in the book Bringing Down the House and movie 21 were Thorp acolytes).4 But there were limits to how much Thorp could make at the gaming tables, especially with the casino bosses doing all they could to thwart him. Thorp decided to put his skills to work where the odds were better and the potential payoffs bigger.

…

., 121 Asian currency crisis, 241 Asness, Cliff, 259–60, 260–61, 262 asset-backed securities, xii AT&T, 42, 220 Austrian School, 49, 301 Babson, Roger, 16–17, 19, 23–26, 31, 35, 204, 209, 263, 322 Bachelier, Louis, 6–8, 13–14, 27, 55–56, 65–66, 68, 71, 144, 148–49, 322 Bacon, Francis, 30 Baker, James, 230 Baker, Malcolm, 300 Ball, Ray, 205 Bänz, Rolf, 205–6, 225 Barclays Global Investors, 143 Barra, 139, 142, 224 Barron’s, 116, 265 Bass, Thomas, 304 The Battle for Investment Survival (Loeb), 57 bear markets, 5, 18, 338n. 16 Beard, Charles, 156 Beat the Dealer (Thorp), 217 Beat the Market (Thorp and Kassouf), 218, 219 Beaver, Bill, 135–36 behavioral finance and Black, 201 current state of, 298, 299–300 and economic decision making, 292–95, 295–97 and Friedman, 188 and media coverage, 200–201, 291–92, 358–59n. 23 and Skinner, 355n. 2 and Thaler, 186–87, 201, 288–89, 292–95, 296–97, 298 “Belief in the Law of Small Numbers” (Kahneman and Tversky), 177 Bell Labs, 42 Bellow, Saul, 89 Benartzi, Shlomo, 294 Benhamou, Eric, 262 Berkshire Hathaway, 216, 221–23, 260 Berle, Adolf, Jr., 154, 160, 165–66, 274, 352n. 3 Bernanke, Ben, xiii, 183 Bernoulli, Daniel, 51 beta, 87, 122–23, 126–27, 139, 152, 205, 207–8, 248–49, 345–46n. 30 Black, Fischer and asset pricing, 141, 149, 248, 322, 346–47n. 30 death, 235 and efficiency, 224 and Goldman Sachs, 224 and “joint hypothesis,” 105 and market crashes, 231 and market volatility, 138 and options, 144–47, 149, 277–78 and Ross, 150 and Shefrin and Statman, 358n. 25 and Summers, 199–201 and Thorp, 219 and Wells Fargo, 127 Black-Scholes formula, 147, 218–19, 233–34,237, 278–79, 280, 320 Bogle, John C., 112–13, 115, 122, 128–30, 306, 322 Bok, Derek, 169 bonds and bond markets, xi–xii, 13–14, 16, 21–22, 29, 38–39, 140–41, 167–68 book-to-price ratio, 208–9 Booth, David, 225 Bork, Robert, 158 Born, Brooksley, 244 Bossaerts, Peter, 297 Brealey, Richard, 355n. 38 Brennan, Michael, 284 Bretton Woods system, 92 Brinegar, Claude, 43–44 Brooks, John, 68, 118 Brown, Kathleen, 278 Brownian motion, 7, 13, 41, 65–69, 73 Bryan, William Jennings, 11 “Bubble Logic: Or, How I Learn to Stop Worrying and Love the Bull” (Asness), 261 Buchanan, James M., 159 Buffet, Warren, 118, 211–14, 214–16, 221–23, 229, 260, 271, 278–79, 323, 366n. 29 bull markets, 18, 61–62, 255, 279, 291 Burns, Arthur, 76, 217, 258 Bush, George W., 295 business cycle, 19–20, 28, 81, 309–10 Business Cycle Institute, 41 Business Week, 97–98 California Institute of Technology, 147 California Public Employees Retirement System (Calpers), 272, 273–74 Cambridge, University, 64 Camerer, Colin, 188 Cameron, David, 295 Campaign GM, 159 Campbell, John, 257 capital asset pricing model (CAPM).

**
Fear and loathing in Las Vegas: a savage journey to the heart of the American dream
** by
Hunter S. Thompson

Amazon: amazon.com — amazon.co.uk — amazon.de — amazon.fr

beat the dealer, South China Sea

Where do they come from? They look like caricatures of used-car dealers from Dallas. But they’re real. And, sweet Jesus, there are a hell of a lot of them – still screaming around these desert-city crap tables at four-thirty on a Sunday morning. Still humping the American Dream, that vision of the Big Winner somehow emerging from the lastminute pre-dawn chaos of a stale Vegas casino. Big strike in Silver City. Beat the dealer and go home rich. Why not? I stopped at the Money Wheel and dropped a dollar on Thomas Jefferson – a $2 bill, the straight Freak ticket, thinking as always that some idle instinct bet might carry the whole thing off. But no. Just another two bucks down the tube. You bastards! No. Calm down. Learn to enjoy losing. The important thing is to cover this story on its own terms; leave the other stuff to Life and Look – at least for now.

pages: 181 words: 54,629

**
Fear and Loathing in Las Vegas
** by
Hunter S. Thompson,
Ralph Steadman

beat the dealer, New Journalism, South China Sea

Where do they come from? They look like caricatures of used-car dealers from Dallas. But they’re real. And, sweet Jesus, there are a hell of a lot of them—still screaming around these desert-city crap tables at four-thirty on a Sunday morning. Still humping the American Dream, that vision of the Big Winner somehow emerging from the last-minute pre-dawn chaos of a stale Vegas casino. Big strike in Silver City. Beat the dealer and go home rich. Why not? I stopped at the Money Wheel and dropped a dollar on Thomas Jefferson—a $2 bill, the straight Freak ticket, thinking as always that some idle instinct bet might carry the whole thing off. But no. Just another two bucks down the tube. You bastards! No. Calm down. Learn to enjoy losing. The important thing is to cover this story on its own terms; leave the other stuff to Life and Look—at least for now.

**
What the Dormouse Said: How the Sixties Counterculture Shaped the Personal Computer Industry
** by
John Markoff

Amazon: amazon.com — amazon.co.uk — amazon.de — amazon.fr

Any sufficiently advanced technology is indistinguishable from magic, Apple II, back-to-the-land, beat the dealer, Bill Duvall, Bill Gates: Altair 8800, Buckminster Fuller, California gold rush, card file, computer age, computer vision, conceptual framework, cuban missile crisis, Donald Knuth, Douglas Engelbart, Douglas Engelbart, Dynabook, Edward Thorp, El Camino Real, Electric Kool-Aid Acid Test, general-purpose programming language, Golden Gate Park, Hacker Ethic, hypertext link, informal economy, information retrieval, invention of the printing press, Jeff Rulifson, John Markoff, John Nash: game theory, John von Neumann, Kevin Kelly, knowledge worker, Mahatma Gandhi, Menlo Park, Mother of all demos, Norbert Wiener, packet switching, Paul Terrell, popular electronics, QWERTY keyboard, RAND corporation, RFC: Request For Comment, Richard Stallman, Robert X Cringely, Sand Hill Road, Silicon Valley, Silicon Valley startup, South of Market, San Francisco, speech recognition, Steve Crocker, Steve Jobs, Steve Wozniak, Steven Levy, Stewart Brand, Ted Nelson, Thorstein Veblen, Turing test, union organizing, Vannevar Bush, Whole Earth Catalog, William Shockley: the traitorous eight

There was no dramatic link as in the case of Kerry Mullis’s invention of PCR. Years later, however, when people would ask about the inventive ideas in Smalltalk, Ingalls would joke, “Well, where do you think these ideas came from?!” Ingalls demonstrated the new feature to one of the large weekly meetings of the PARC researchers in the fall of 1974. The gatherings were known as “Dealers” and had been instituted by Taylor, who took the name from the book Beat the Dealer by Edward O. Thorp, the MIT professor who had developed a system for winning at blackjack. Taylor was taken by the image of a nerdy math professor beating the house. The meetings became forums for both technical presentations and a kind of group interview system for job candidates. The demonstration of BitBlt had a dramatic impact both inside and outside of Kay’s group. One person who watched the demonstration was Don Wallace.

**
A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing
** by
Burton G. Malkiel

Amazon: amazon.com — amazon.co.uk — amazon.de — amazon.fr

3Com Palm IPO, accounting loophole / creative accounting, Albert Einstein, asset allocation, asset-backed security, backtesting, beat the dealer, Bernie Madoff, BRICs, capital asset pricing model, compound rate of return, correlation coefficient, Credit Default Swap, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Edward Thorp, Elliott wave, Eugene Fama: efficient market hypothesis, experimental subject, feminist movement, financial innovation, fixed income, framing effect, hindsight bias, Home mortgage interest deduction, index fund, invisible hand, Isaac Newton, Long Term Capital Management, loss aversion, margin call, market bubble, money market fund, mortgage tax deduction, new economy, Own Your Own Home, passive investing, Paul Samuelson, pets.com, Ponzi scheme, price stability, profit maximization, publish or perish, purchasing power parity, RAND corporation, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, short selling, Silicon Valley, South Sea Bubble, survivorship bias, The Myth of the Rational Market, the rule of 72, The Wisdom of Crowds, transaction costs, Vanguard fund, zero-coupon bond

Other things being the same, this should make stock prices fall. But with higher expected inflation, investors may reasonably project that corporate earnings and dividends will also increase at a faster rate, causing stock prices to rise. A fuller discussion of inflation, interest rates, and stock prices is contained in chapter 13. * Edward O. Thorp actually did find a method to win at blackjack. Thorp wrote it all up in Beat the Dealer. Since then, casinos switched to the use of several decks of cards to make it more difficult for card counters and, as a last resort, they banished the counters from the gaming tables. * If such a regularity was known to only one individual, he would simply practice the technique until he had collected a large share of the marbles. He surely would have no incentive to share a truly useful scheme by making it available to others.

**
Trend Following: How Great Traders Make Millions in Up or Down Markets
** by
Michael W. Covel

Amazon: amazon.com — amazon.co.uk — amazon.de — amazon.fr

Albert Einstein, asset allocation, Atul Gawande, backtesting, beat the dealer, Bernie Madoff, Black Swan, buy low sell high, capital asset pricing model, Clayton Christensen, commodity trading advisor, computerized trading, correlation coefficient, Daniel Kahneman / Amos Tversky, delayed gratification, deliberate practice, diversification, diversified portfolio, Edward Thorp, Elliott wave, Emanuel Derman, Eugene Fama: efficient market hypothesis, Everything should be made as simple as possible, fiat currency, fixed income, game design, hindsight bias, housing crisis, index fund, Isaac Newton, John Meriwether, John Nash: game theory, linear programming, Long Term Capital Management, mandelbrot fractal, margin call, market bubble, market fundamentalism, market microstructure, mental accounting, money market fund, Myron Scholes, Nash equilibrium, new economy, Nick Leeson, Ponzi scheme, prediction markets, random walk, Renaissance Technologies, Richard Feynman, Richard Feynman, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, shareholder value, Sharpe ratio, short selling, South Sea Bubble, Stephen Hawking, survivorship bias, systematic trading, the scientific method, Thomas L Friedman, too big to fail, transaction costs, upwardly mobile, value at risk, Vanguard fund, volatility arbitrage, William of Occam, zero-sum game

The Futures Game. Who Wins? Who Loses? Why? New York: McGraw-Hill, 1987. Thaler, Richard H. Mental Accounting Matters. Journal of Behavioral Decision Making, 12 (1999): 183–206. Thaler, Richard H. Saving, Fungibility, and Mental Accounts. Journal of Economic Perspectives, Vol. 4, No. 1 (Winter 1990): 193–205. Tharp, Van K. Trade Your Way to Financial Freedom. New York: McGraw-Hill, 1999. Thorp, Edward O. Beat the Dealer. New York: Vintage Books, 1966. Toffler, Alvin. Future Shock. New York: Bantam Books, 1971. Tully, Shawn. Princeton’s Rich Commodity Scholars. Fortune, 9 (February 1981): 94. Tversky, Amos and Daniel Kahneman. Belief in the Law of Small Numbers. Psychological Bulletin, 76 (1971): 105–110. Tzu, Sun. The Art of War. Boston and London: Shambhala, 1988. Ueland, Brenda. If You Want to Write: A Book About Art, Independence and Spirit.

**
A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation
** by
Richard Bookstaber

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affirmative action, Albert Einstein, asset allocation, backtesting, beat the dealer, Black Swan, Black-Scholes formula, Bonfire of the Vanities, butterfly effect, commoditize, commodity trading advisor, computer age, computerized trading, disintermediation, diversification, double entry bookkeeping, Edward Lorenz: Chaos theory, Edward Thorp, family office, financial innovation, fixed income, frictionless, frictionless market, George Akerlof, implied volatility, index arbitrage, intangible asset, Jeff Bezos, John Meriwether, London Interbank Offered Rate, Long Term Capital Management, loose coupling, margin call, market bubble, market design, merger arbitrage, Mexican peso crisis / tequila crisis, moral hazard, Myron Scholes, new economy, Nick Leeson, oil shock, Paul Samuelson, Pierre-Simon Laplace, quantitative trading / quantitative ﬁnance, random walk, Renaissance Technologies, risk tolerance, risk/return, Robert Shiller, Robert Shiller, rolodex, Saturday Night Live, selection bias, shareholder value, short selling, Silicon Valley, statistical arbitrage, The Market for Lemons, time value of money, too big to fail, transaction costs, tulip mania, uranium enrichment, William Langewiesche, yield curve, zero-coupon bond, zero-sum game

While many who were at Morgan Stanley at the time can retell the story of Bamberger’s discovery of stat arb, its epilogue remains a blank page. Bamberger headed off to Princeton Newport, where he continued to pursue the strategy with the legendary Ed Thorp for a year, made a small fortune, and then disappeared from the world of trading. This move was a natural. Thorp was the first great analytically oriented trader. An MIT mathematician, he was the author of Beat the Dealer (Random House, 1966), which introduced the concept of card counting to blackjack. He wrote the book to spread his techniques after he had been banned by most casinos and could no longer pursue the strategy for profit. The next year he wrote Beat the Market (Random House, 1967), which formed the basis of convertible bond arbitrage, a strategy that remains the mainstay of many hedge funds. While I was still a professor in 1983 (the year before I left academia for Wall Street), I got a call from Ed to interview at his firm in Newport Beach, California.

**
New Market Wizards: Conversations With America's Top Traders
** by
Jack D. Schwager

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backtesting, beat the dealer, Benoit Mandelbrot, Berlin Wall, Black-Scholes formula, butterfly effect, commodity trading advisor, computerized trading, Edward Thorp, Elliott wave, fixed income, full employment, implied volatility, interest rate swap, Louis Bachelier, margin call, market clearing, market fundamentalism, money market fund, paper trading, pattern recognition, placebo effect, prediction markets, Ralph Nelson Elliott, random walk, risk tolerance, risk/return, Saturday Night Live, Sharpe ratio, the map is not the territory, transaction costs, War on Poverty

So I didn’t want to have anything to do with it. After your job was eliminated, did you get another position as an analyst? No, I got a job selling time on large computers. However, that position was essentially a marketing slot, and I was interested in doing analytical work. After about a year, I left to take a job in operations research for Kaiser Cement. At that time, I got interested in playing blackjack by reading a book called Beat the Dealer by Ed Thorp. From 1971 to 1975, I went to the Nevada casinos regularly. Did you live in Nevada at the time? No, I lived in California. But I would take a blackjack trip every chance I got. I probably spent about five days a month in Nevada during that time. In a sense, I owe everything that I have to the state of Nevada. It not only provided me with my original trading stake, but the betting experience taught me a lot of things that allowed me to become a successful trader.