The genius who outsmarted the casino and Wall Street
Lessons from Edward Thorp on how to beat the market by applying casino strategies
This is the story of a brilliant investor you’ve probably never heard of. He made his first million in the casino. Not by luck, but by ensuring the odds were in his favor.
Thorp outsmarted the casino by counting cards and inventing the first portable computer to predict where the roulette ball would land. He operated this device using his big toe!
Of course, this doesn't mean you have to cheat. An edge can take many forms, listed from the most challenging to the easiest.
Edge 1: Having more information than other investors
Edge 2: Interpreting available data better than others
Edge 3: Simply being more patient
In a casino, your only real edge is information. After being banned from every casino in America, Thorp took his winnings to the largest casino in the world: the stock market.
After making several beginner mistakes, Thorp applied a lesson from his gambling days. He used data to gain an edge, creating a mathematical model to trade call options. This strategy earned him an impressive 20% return annually. When his models stopped working, Thorp did something only a few investors are capable of: he quit.
Could Thorp make even more brilliant decisions?
Amazingly, yes. In 1968, after meeting Warren Buffett during Bridge, Thorp predicted that Buffett would one day become the richest man in the world. He recognized Buffett's incredible intelligence, his ability to compound at a high rate, and his capacity to sustain that growth over time.
After losing touch with Buffett, Thorp came across an article in 1982 about Berkshire Hathaway and its CEO, Warren Buffett. By then, Berkshire’s stock had risen from $12 to $982 per share. Despite the 81-fold increase, Thorp decided to invest in Berkshire. This was a decision that paid off once again.
To continue this unbelievable story, here’s another fascinating fact. In 1991, Thorp advised McKinsey against investing in Bernie Madoff’s portfolio (later revealed as the largest Ponzi scheme in history). Thorp had discovered something was mathematically wrong but couldn’t prove the fraud.
Thorp told McKinsey:
“Your other investments return 16% annually. If I’m right, you’ll lose your job. If I’m wrong, you’ll lose just 4% of returns. Just exit.”
It took another 17 years before Madoff’s fraud was fully exposed.
This lesson is applicable not only to investing but also to your overall well-being. While it may sound oversimplified, many of the rules that apply to investing are also true for personal well-being: Healthy decisions compound, and taking unnecessary risks is never worth it.
How Thorp applied this to his life:
Thorp was one of the first to self-isolate during COVID-19 because he deemed the risk too high.
At age 30, after struggling to climb stairs without getting winded, he started running one mile every Saturday. He eventually completed 21 marathons.
At age 90, Thorp still does squats, pull-ups, and walks four times a week.
After being advised to take up cycling, Thorp researched how many people die in biking accidents each year. He decided the risk wasn’t worth it.
This brings us to the last lesson of today: Even though we all share the same passion, there are things in life more important than investing.
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Have a wonderful day and happy investing.
The Dutch Investors
📚Lessons to remember from this article:
Only bet when the odds are in your favor
You need an edge to secure good returns
Know when to quit
There are three key ingredients to becoming wealthy: avoid expensive mistakes, compound at a high rate, and sustain it for a long time
Don’t let past performance influence you; focus on valuation, management, and business quality
Never bet the farm. Always ensure you live to fight another day, no matter the potential reward.
Even though we all share the same passion, there are things in life more important than investing.