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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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In 1956 two Bell Labs scientists discovered the scientific formula for getting rich. One was mathematician Claude Shannon, neurotic father of our digital age, whose genius is ranked with Einstein’s. The other was John L. Kelly Jr., a Texas-born, gun-toting physicist. Together they applied the science of information theory—the basis of computers and the Internet—to the problem of making as much money as possible, as fast as possible.
Shannon and MIT mathematician Edward O. Thorp took the “Kelly formula” to Las Vegas. It worked. They realized that there was even more money to be made in the stock market. Thorp used the Kelly system with his phenomenonally successful hedge fund, Princeton-Newport Partners. Shannon became a successful investor, too, topping even Warren Buffett’s rate of return. Fortune’s Formula traces how the Kelly formula sparked controversy even as it made fortunes at racetracks, casinos, and trading desks. It reveals the dark side of this alluring scheme, which is founded on exploiting an insider’s edge.
Shannon believed it was possible for a smart investor to beat the market—and Fortune’s Formula will convince you that he was right. William Poundstone is the bestselling author of nine nonfiction books, including Labyrinths of Reason and The Recursive Universe. In 1956 two Bell Labs scientists discovered the scientific formula for getting rich. One was mathematician Claude Shannon, neurotic father of our digital age, whose genius is ranked with Einstein's. The other was John L. Kelly Jr., a Texas-born, gun-toting physicist. Together they applied the science of information theory—the basis of computers and the Internet—to the problem of making as much money as possible, as fast as possible.
Shannon and MIT mathematician Edward O. Thorp took the "Kelly formula" to Las Vegas. It worked. They realized that there was even more money to be made in the stock market. Thorp used the Kelly system with his phenomenonally successful hedge fund, Princeton-Newport Partners. Shannon became a successful investor, too, topping even Warren Buffett's rate of return. Fortune's Formula traces how the Kelly formula sparked controversy even as it made fortunes at racetracks, casinos, and trading desks. It reveals the dark side of this alluring scheme, which is founded on exploiting an insider's edge.
Shannon believed it was possible for a smart investor to beat the market—and Fortune's Formula will convince you that he was right. "Fortune's Formula may be the world's first history book, gambling primer, mathematics text, economics manual, personal finance guide and joke book in a single volume. Poundstone comes across as the best college professor you ever hand, someone who can turn almost any technical topic into an entertaining and zesty lecture."—The New York Times Book Review "Fortune's Formula may be the world's first history book, gambling primer, mathematics text, economics manual, personal finance guide and joke book in a single volume. Poundstone comes across as the best college professor you ever hand, someone who can turn almost any technical topic into an entertaining and zesty lecture."—The New York Times Book Review "Seldom have true crime and smart math been blended together so engagingly"—The Wall Street Journal
"An amazing story that gives a big idea the needed star treatment . . . Fortune's Formula will appeal to readers of such books as Peter L. Bernstein's Against the Gods, Nassim Nicholas Taleb's Fooled by Randomness, and Roger Lowenstein's When Genius Failed. All try to explain why smart people take stupid risks. Poundstone goes them one better by showing how hedge fund Long-Term Capital Management, for one, could have avoided disaster by following the Kelly method."—Business Week "Poundstone, a two-time Pulitzer Prize nominee, takes us from chalkboard to stock market and back as he explains the 'Kelly formula' for gambling through the lives of those who developed and exploited the system. It is a rollicking tale about money, mathematics and greed."—Bloomberg "A dazzling array of math geniuses, rogues, swindlers, Nobel Prize winners, gun-toting physicists—all massaging the formulas that give them an edge in creating fortunes."—George J. W. Goodman (aka "Adam Smith"), author of The Money Game and Supermoney "This is a wonderful tale of how mathematics got married to gambling and went off to honeymoon in Las Vegas, before finding ultimate happiness in the biggest casino of all—the world financial markets. Poundstone has produced a rogues' gallery of mobsters and mathematicians, kneecappers and handicappers, card sharps, professors, systems players, numbers runners, and number crunchers—the best 'investment advisers' you can find. Anyone interested in playing the markets should buy this book and read it immediately."—Thomas A. Bass, author of The Eudaemonic Pie and The Predictors "The true story of the intertwining lives of financial legends, mathematical geniuses and crooked mobsters. Who would you expect to win an intellectual battle between professional gamblers and Nobel Prize winners? This book confirms what I'd long suspected, that the successful gambler knows more about managing money than the most PhD-laden investment banker. Poundstone's book explains that knowledge, and you'll be surprised by its elegance and simplicity. A fascinating book, both a cracking good yarn and a practical guide for investment success."—Paul Wilmott, mathematician, bestselling author, and editor of Wilmott magazine "From bookies to billionaires, you'll meet a motley cast of characters in this highly original, 'outside the box' look at gambling and investing. Read it for the stories alone, and you'll be surprised at how much else you can learn without even trying." —Edward O. Thorp, author of Beat the Dealer and Beat the Market "What a fantabulous book! Fortune's Formula provides a deep but crystal-clear understanding of information theory, card-counting schemes, plunging necklines, mean-variance mapping, junk bonds sold short and gambler's ruin, all part of an epic suspense tale crowded with eccentric geniuses and cold-blooded killers. You'll never follow a horse race, push forward a casino chip or enter a market the same way again. Read this and weep for the edge you only thought that you had, then read it again for a real one."—James McManus, author of Positively Fifth Street
- Sales Rank: #578680 in Books
- Brand: Brand: Hill and Wang
- Published on: 2005-09-14
- Released on: 2005-08-25
- Original language: English
- Number of items: 1
- Dimensions: 9.00" h x 1.00" w x 6.00" l, 1.41 pounds
- Binding: Hardcover
- 400 pages
- Used Book in Good Condition
Amazon.com Review
Fortune's Formula is a fascinating study of the connections between such seemingly unrelated topics as gambling, information theory, stock investing, and applied mathematics. The story involves the stunning brainpower of men such as MIT professor Claude Shannon, who single-handedly invented information theory, the science behind the Internet and all digital media; Ed Thorpe; and John Kelly of Bell Laboratories, who developed the "Kelly criterion," a now-legendary investment strategy for maximizing growth while controlling risk. Initially, Shannon and Thorpe took Kelly's theory to Las Vegas and applied it to roulette and blackjack. Later, they took it to Wall Street and cleaned up--Shannon made a personal fortune while Thorpe created the highly successful hedge firm Princeton-Newport Partners. They both discovered that Kelly's system was particularly effective when applied to arbitrage (minute price differences that result from market inefficiencies). As Poundstone ably demonstrates, the merits of Kelly's criterion are still hotly debated today.
Poundstone has a tendency to meander in his writing, but his asides are so revealing and interesting that they add, rather than detract, from the narrative. The book also includes a cast of fascinating and colorful characters as varied as Ivan Boesky, Warren Buffet, Rudolph Giuliani, and notorious mobsters such as Bugsy Siegel and Meyer Lansky. In explaining the lasting impact of the work done by Shannon, Thorpe, and Kelly, Poundstone even explains Kelly's system for those wishing to follow his formula, offering readers both theoretical and practical lessons. Whether viewed as a how-to guide or straight scientific and financial history, Fortune's Formula proves an entertaining and illuminating analysis of "the most successful gambling system of all time." --Shawn Carkonen
From Publishers Weekly
In 1961, MIT mathematics professor Ed Thorp made a small Vegas fortune by "counting cards"; his 1962 bestseller, Beat the Dealer, made the phrase a household word. With Claude Shannon, the father of information theory, Thorp next conquered the roulette tables. In this prosaic but fascinating cultural history, Poundstone (How Would You Move Mt. Fuji?) tells not only what they did but how they did it. For roulette, Poundstone shows, Thorp and Shannon used a betting scheme invented by Shannon's Bell Labs colleague John Kelly, eventually applying Kelly's technique to investing, resulting in long-term records of extraordinary return with low risk. (Thorp revealed the secret in 1966's Beat the Market, but investors proved harder to persuade than blackjack players.) Many other characters figure into Poundstone's entertaining saga: a forgotten French mathematician, two Nobel Prize–winning economists who declared war on the Kelly criterion, Rudy Giuliani, assorted mobsters, and winners and losers in all types of investing and gambling games. The subtitle is not a tease: the book explains and analyzes Kelly's system for turning small advantages into great wealth. The system works, but requires unusual amounts of patience, discipline and courage. The book is good fun for the rest of us.
Copyright © Reed Business Information, a division of Reed Elsevier Inc. All rights reserved.
Review
“Seldom have true crime and smart math been blended together so engagingly” -- The Wall Street Journal
“An amazing story that gives a big idea the needed star treatment….Fortune's Formula will appeal to readers of such books as Peter L. Bernstein's Against the Gods, Nassim Nicholas Taleb's Fooled by Randomness, and Roger Lowenstein's When Genius Failed. All try to explain why smart people take stupid risks. Poundstone goes them one better by showing how hedge fund Long-Term Capital Management, for one, could have avoided disaster by following the Kelly method.” --Business Week (four stars)
“Poundstone, a two-time Pulitzer Prize nominee, takes us from chalkboard to stock market and back as he explains the ``Kelly formula' for gambling through the lives of those who developed and exploited the system. It is a rollicking tale about money, mathematics and greed.” --Bloomberg.com
“’Fortune’s Formula’ may be the world’s first history book, gambling primer, mathematics text, economics manual, personal finance guide and joke book in a single volume. Poundstone comes across as the best college professor you ever hand, someone who can turn almost any technical topic into an entertaining and zesty lecture.” — The New York Times Book Review
"A dazzling array of math geniuses, rogues, swindlers, Nobel Prize winners, gun-toting physicists--all massaging the formulas that give them an edge in creating fortunes." --George J. W. Goodman (aka "Adam Smith"), author of The Money Game and Supermoney
"This is a wonderful tale of how mathematics got married to gambling and went off to honeymoon in Las Vegas, before finding ultimate happiness in the biggest casino of all–the world financial markets. Poundstone has produced a rogues' gallery of mobsters and mathematicians, kneecappers and handicappers, card sharps, professors, systems players, numbers runners, and number crunchers–the best 'investment advisers' you can find. Anyone interested in playing the markets should buy this book and read it immediately." --Thomas A. Bass, author of The Eudaemonic Pie and The Predictors
"The true story of the intertwining lives of financial legends, mathematical geniuses and crooked mobsters. Who would you expect to win an intellectual battle between professional gamblers and Nobel Prize winners? This book confirms what I'd long suspected, that the successful gambler knows more about managing money than the most PhD-laden investment banker. Poundstone's book explains that knowledge, and you'll be surprised by its elegance and simplicity. A fascinating book, both a cracking good yarn and a practical guide for investment success." --Paul Wilmott, mathematician, bestselling author, and editor of Wilmott magazine
"From bookies to billionaires, you'll meet a motley cast of characters in this highly original, 'outside the box' look at gambling and investing. Read it for the stories alone, and you'll be surprised at how much else you can learn without even trying." --Edward O. Thorp, author of Beat the Dealer and Beat the Market
"What a fantabulous book! Fortune's Formula provides a deep but crystal-clear understanding of information theory, card-counting schemes, plunging necklines, mean-variance mapping, junk bonds sold short and gambler's ruin, all part of an epic suspense tale crowded with eccentric geniuses and cold-blooded killers. You'll never follow a horse race, push forward a casino chip or enter a market the same way again. Read this and weep for the edge you only thought that you had, then read it again for a real one." --James McManus, author of Positively Fifth Street
Most helpful customer reviews
52 of 54 people found the following review helpful.
The Ongoing Epic of the Kelly Criterion for Risk Management.
By mirasreviews
"Fortune's Formula" tells the story of the Kelly Criterion -through the experiments, ideas, wins, and losses of those who have espoused it and who have derided it, at race tracks, black jack tables, sports books, and, finally, on Wall Street. The Kelly Criterion is a risk management formula published in 1956 by Bell Labs information theorist John Kelly, Jr. that dictates how much of your bankroll you should bet based on your edge divided by the odds so that you will have zero risk of ruin no matter how bad your luck is, while increasing wealth faster than any other betting system. It does not address what bets you should make, which is another matter entirely. Instead of writing a simple analysis of the Kelly Criterion, author William Poundstone brings this story alive by relating the histories of key figures who have used, promoted, or criticized the Kelly Criterion: information theorists, economists, traders, gamblers, and gangsters. Some readers may find this approach unfocused and unnecessary. But I think the personalities lend "Fortune's Formula" an epic quality and place the Kelly Criterion firmly in the context of real life, with real consequences, as opposed to the realm of abstruse theories that never leave the halls of academe.
The men whom "Fortune's Formula" casts as protagonists are Claude Shannon, the MIT scholar who invented information science and who amassed a small fortune as a buy-and-hold investor, typically making 28% per year on a small portfolio, and Ed Thorpe, author of 1962's gambling classic "Beat the Dealer", 1967's "Beat the Market", co-founder of Princeton-Newport Partners fund (1969-1988) and founder of Ridgeline Partners (1994-2002) quant fund. Ed Thorpe's transformation from MIT egghead to black jack sharp to Wall Street wizard in an ongoing theme, as Thorpe is an immensely successful advocate of the Kelly Criterion -and he is still alive. There is unfortunately little information on John Kelly, because he died in 1965 at the age of 41. The key Kelly challenger is 1970 Nobel Laureate economist Paul Samuelson, who probably overstates his case in calling the Kelly Criterion a "complete swindle" when the point of disagreement seems to be the concept of "utility" in long-tern outcome. Whatever one thinks of Samuelson's outspoken arrogance, he is certainly entertaining. Mobster Manny Kimmel makes an appearance, as do traders Ivan Boesky, Michael Milken, and John Meriwether, as well as numerous information theorists.
William Poundstone obviously has a point of view. He is an advocate of the Kelly Criterion, believing that it produces better results than any other betting system over the long haul while withstanding even the most unlikely confluences of catastrophe that have a way of manifesting themselves periodically. He doesn't support efficient market hypothesis. He thinks people can, and have, made money consistently on the stock market. -But that you need a darned good method of managing risk to do it, a better method than Value at Risk reports. "Fortune's Formula"'s fascination is not only in its history of the Kelly Criterion, but in the realization that a risk management formula has so many seemingly disparate applications. As Poundstone says, "The idea pops up in the strangest places."
0 of 0 people found the following review helpful.
This book proved that most mathematicians live in a different ...
By Lawrence Pearce
This book proved that most mathematicians live in a different world than our reality. Example: The mathematician who claimed that you could win money if you bet on every horse in the race. However, he failed to account for the money deducted by the race track, which would disprove his claim. The biggest laugh comes from the story of the two Nobel Prize winning mathematicians who started a hedge fund. It's worth the price of this used book.
7 of 7 people found the following review helpful.
It takes exceptionally smart people to make truly massive blunders
By Dave Snell
This book is a concise look at the evolution of formal investment theory, with continual contextual references to its ties to gambling and to organized crime. It also is a hilarious and insightful history of gambling from the Bernoulli's in the 1700s through the hedge fund traders of the late 1990's.
The author devotes over 50 pages to notes and the index. This was appreciated since I wanted to look up more about so many of the anecdotes he included.
Mr. Poundstone poignantly describes the downfall of high-flying firms such as LTCM, where the investment wizards went from the darlings of Wall Street to the dredges of the investment community in large part because they were so clever; and they started to believe they were infallible.
One LTCM road-show presentation was held at the insurance company Conseco in Indianapolis. Andrew Chow, a Conseco derivatives trader, interrupted Scholes. "There aren't that many opportunities," Chow objected. "You can't make that kind of money in Treasury markets."
Scholes snapped: "You're the reason - because of fools like you we can." (Page 281)
Warren Buffett marveled at how "ten or 15 guys with an average IQ of maybe 170" could get themselves "into a position where they can lose all their money." That was much the sentiment of Daniel Bernoulli, way back in 1738, when he wrote: "A man who risks his entire fortune acts like a simpleton, however great may be the possible gain." (Page 291)
He also points out the real world flaws in some theoretically appealing scams. The St. Petersburg Wager seems mathematically correct; yet it overlooks a vitally important constraint (pages 182-184). Another is the unfounded weight we unconsciously give to historical returns, as evidenced by his retelling of another Warren Buffett story:
In a 1984 speech, Buffett asked his listeners to imagine that all 215 million Americans pair off and bet a dollar on the outcome of a coin toss. The one who calls the toss incorrectly is eliminated and pays his dollar to the one who was correct.
The next day, the winners pair off and play the same game with each other, each now betting $2. Losers are eliminated and that day's winners end up with $4. The game continues with a new toss at doubled stakes each day. After twenty tosses, 215 people will be left in the game. Each will have over a million dollars.
According to Buffett, some of these people will write books on their methods: "How I Turned a Dollar into a Million in Twenty Days Working Thirty Seconds a Morning." Some will badger ivory-tower economists who say it can't be done: "If it can't be done, why are there 215 us?" "Then some business school professor will probably be rude enough to bring up the fact that if 215 million orangutans had engaged in a similar exercise, the result would be the same - 215 egotistical orangutans with 20 straight winning flips." (Page 314)
The author follows the lives of a few major contributors to investment theory, information theory, and betting theory: Claude Shannon, who invented Information Theory and paved the way for the digital computer age; John Kelly, who developed the formula for gains with no possibility of ruin; and Edward Thorpe, who built upon these findings and beat the roulette wheels, the blackjack tables and the investment fund managers.
It's a fast read - only 329 pages before the notes and index. I highly recommend it!
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