“Fortune’s Formula” is the Kelly Criterion from J.L. Kelly Jr. who was a mathematician at Bell Labs in the 1950s. Essentially the formula gives the optimal size of bets in order to win as much as possible over time while reducing the risk of ruin. The thing for the reader to realize is that the Kelly Criterion has no utility unless the bettor or investor has an advantage. That needs to be repeated: on an even bet, such as tossing a coin the Kelly strategy is to bet nothing, zero, zilch.
Before I get into the review of this excellent and very interesting book I want to relate an experience I had some years ago, sometime in the early 1980s. I thought I had come up with a way to bet on baseball games in Las Vegas with an advantage over the line (that is over the bookie’s vigorish). For a season I studied results compared to the betting line. I was so sure I had a clear advantage that the next problem became how to run up my money efficiently without taking the chance of going broke. In other words, non-mathematician that I am, I was seeking something like Kelly’s Criterion. And what I came up with turned out to be very similar to his formula, although I don’t recall exactly. Unfortunately when I got to Las Vegas it didn’t take me long to realize I had no advantage and therefore didn’t make any bets.
Okay, back to the book. An excellent way to get an idea of the scope of this work is to look at the parts. Part One is titled “Entropy,” Part Two is “Blackjack,” Part Three is “Arbitrage,” Part Four is “St Petersburg Wager,” Part Five is “RICO” (Racketeer-Influenced and Corrupt Organization), Part Six is “Blowing Up,” and Part Seven is “Signal and Noise.” Along the way you will meet gangsters, the Italian and Jewish mafias, a young and very aggressive Rudolph Giuliani, the Hong Kong horseracing scene in which some people made millions (it was the only legal betting allowed by law in Hong Kong) and some keen ideas on how to make money gambling or investing. But what really makes this book so interesting is the light that Poundstone shines on two giants in the science of information, gambling and investing, namely Claude Shannon and Edward O. Thorp.
Shannon is known as the father of information theory and in many respects as the founder of the digital world we live in today. He was also an astute investor as Poundstone reveals. I don’t think it would be an exaggeration to say that Shannon was a genius.
Thorp first became known to the public with his book “Beat the Dealer” (first edition, 1962) which presented a winning strategy for blackjack. I read that book when I was still in my twenties with great enthusiasm but never employed the strategies since my memory is rather ordinary. Instead I played poker, but that, as they say, is another story. What is astonishing about Thorp that I learned here is that his hedge fund, Princeton-Newport Partners was one of the most successful ever. A dollar invested in the fund in 1969 would grow to $14.78 in1988. Yes, wow.
Poundstone explains in detail how all this happened and it is a fascinating story. I’m amazed at how much work he put into this book and all the information he acquired. He is an outstanding and prolific journalist as well as an MIT grad, although I must say that the organization of the book was a bit freestyle. Additionally there are some errors and some unclear passages. Consider this on page 39: Ed Thorp (as a boy) “would buy a pack of Kool-Aid for five cents and sell the mixed beverage to hot WPA workers for one cent a glass. Ed could get six glasses from a pack for a penny profit.”
What is not right here is that you needed to add sugar to the Kool Aid which would be an additional expense.
On page 68, Poundstone writes: “Kelly described his idea this way: A ‘gambler with a private wire’ gets advanced word of the outcome of baseball games or horse races…”
It’s unclear what year this was but regardless of the year you can’t get “advanced word of the outcome” of a baseball game.
One more example: Poundstone writes: “In 1993 Ed Thorp” learned from a computer science person who “had discovered” that pro basketball teams “that had to travel to the city in which a game was played tended to do poorer than a team that didn’t have to travel. A team that had to play a number of games in a row did poorer on average than a team given more rest between games. These variables were not properly weighted in bookies’ odds.” (p. 322)
This is not true even in 1993. The two factors mentioned are just exactly the sorts of factors that are built into the bookies’ betting line, as any serious sports bettor knows.
Part of the pleasure in reading this book is in the way that Poundstone exposes stupidity in what would seem to be high places. Here’s a quote from Mark Rubenstein who is a professor of finance at UC Berkeley. He’s talking about the Black Monday stock market crash of October 19, 1987:
“So improbable is such an event that it would not be anticipated to occur even if the stock market were to last for 20 billion years, the upper end of the currently estimated duration of the universe. Indeed, such an event should not occur even if the stock market were to enjoy a rebirth for 20 billion years in each of 20 billion big bangs.”
Gee, I hope he was just funning us.
(BTW, my baseball betting delusion came about because I used the line in the Los Angeles Herald Examiner which was a stale line that didn’t account for recency. My approach was to weight recent results more heavily that older results. When I got to Vegas and saw the Vegas line it was clear that their betting lines did indeed consider recency.)
--Dennis Littrell, author of “The World Is Not as We Think It Is”
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Fortune's Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street
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Reviews with images
Isn't that a wonderful book?
Right from the start, the writer engages us in an adventure of people and their passions for abnormal returns via crime or even science. The common thing between all these different but real characters is one thing: their love to be out of the norm. The real fortune that the reader gets is not from a magic formula, but from the story itself. One of the best books for speculation I have ever read.
Top reviews from other countries
KK
Great book for people into casinos and gambling, stock markets and wall street, or simply trying to money
Reviewed in Canada on July 13, 2016
Shashank V. Nerurkar
Distinct approach to betting systems and its use in investing
Reviewed in India on February 13, 2016mzaradzki
mixing top scientific mind and the fringe of our society
Reviewed in France on June 2, 2012