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Fortune's Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street | 
 enlarge | Author: William Poundstone
Publisher: Hill and Wang
Category: Book
List Price: $15.00
Buy New: $8.61
You Save: $6.39 (43%)
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Rating:  57 reviews
Sales Rank: 15465
Media: Paperback
Edition: 1st
Pages: 400
Number Of Items: 1
Shipping Weight (lbs): 0.8
Dimensions (in): 8.1 x 5.5 x 1.2
ISBN: 0809045990
Dewey Decimal Number: 795
EAN: 9780809045990
Publication Date: September 19, 2006
Availability: Usually ships in 1-2 business days
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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
Product Description
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.
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| Customer Reviews: Read 52 more reviews...
 Ed Thorp is a true investment and math genius. September 8, 2005
Gaetan Lion
243 out of 255 found this review helpful
This is an excellent book about the discovery of the Kelly formula that is unknown outside gambling. This story has three protagonists. Two of them were scientists working at Bell Labs: Claude Shannon, a genius polymath who developed information theory; and John Kelly, a maverick genius, who is directly responsible for the development of Kelly's formula. The third one is a brilliant MIT mathematician, Ed Thorp.
Ed Thorp tested the Kelly formula in both gambling and investing. Also, he came up with an options formula before Fischer Black and Myron Scholes. His formula missed a risk-free rate component due to the structure of the market at the time. As a result, Ed Thorp remained in obscurity while Black and Scholes became famous.
Ed Thorp succeeded in deriving superior returns in both gambling and investing. But, it was not so much because of Kelly's formula. He developed other tools to achieve superior returns. In gambling, Ed Thorp succeeded at Black Jack by developing the card counting method. He just used intuitively Kelly's formula to increase his bets whenever the odds were in his favor. Later, he ran a hedge fund for 20 years until the late 80s and earned a rate of return of 14% handily beating the market's 8% during the period. Also, his hedge fund hardly lost any value on black Monday in October 1987, when the market crashed by 22%. The volatility of his returns was far lower than the market. He did this by exploiting market inefficiencies using warrants, options, and convertible bonds. The Kelly formula was for him a risk management discipline and not a direct source of excess return.
Ed Thorp's career as a hedge fund manager was temporarily cut short. This was due to his fund being involved in a tax-avoiding securities scheme with Drexel Burnham. Thorp was not guilty; but, the fund had to be liquidated. The author stated many of Milken wrongdoings. One included getting large equity positions attached to the junk bonds he issued. The companies thought they were issuing convertible bonds. However, the equity component went straight into Milken's pocket as he sold the bonds to investors as high yield debt with no equity attached.
Ed Thorp rebounded from this mishap and started a second hedge fund in 1994. Thorp continued reaping above market return. As the author states, Ed Thorp's genius consists in "...his continuous ability to discover new market inefficiencies ... as old ones played out." Ed Thorp closed this second fund in 2002. He is now independently exploring inefficiencies in gambling.
Claude Shannon amassed large wealth by recording one of the best investment records. His performance had little to do with Kelly's formula. Between 1966 and 1986, his record beat even Warren Buffet (28% to 27% respectively). Shannon strategy was similar to Buffet. Both their stock portfolios were concentrated, and held for the long term. Shannon achieved his record by holding mainly three stocks (Teledyne, Motorola, and HP). The difference between the two was that Shannon invested in technology because he understood it well, while Buffet did not.
John Kelly was a chain smoking, gun collecting brilliant physicist. He died young at 41 of an aneurysm. He worked closely with Shannon at Bell Labs. Besides being a charismatic character the author does not write much about his life compared to the other two (Shannon and Thorp).
The Kelly formula is Edge/Odds (as explained on page 72). In investment circles, this formula is not always useful because it is hard to quantify your Edge (value of proprietary information). However, Kelly's formula has intuitive practical implications. It entails you should focus on an investment internal rate of return (IRR) instead of its average yearly return. The IRR is always less. Another implication is that higher risk is not always compensated by higher return. There is an optimal risk level beyond which risk taking becomes destructive. The author mentions the Long Term Capital Management as a case in point.
I recommend other excellent similar books: "Fischer Black and the Revolutionary Idea of Finance" by Perry Mehrling, and "When Genius Failed. The Rise and Fall of Long Term Capital Management" by Roger Lowenstein. Both these books describe luminaries in finance and investment fields who were often in contact with Ed Thorp and Claude Shannon. Another excellent book is Sylvia Nasar's "A Beautiful Mind" about John Nash, the Game Theorist.
Should be on the 'must read' list for every trader March 7, 2006
Paul M. King (Vermont, USA)
12 out of 14 found this review helpful
If you have ever heard of the Kelly Criteria for position-sizing, or wondered if Optimal F is a good way to manage risk, this book is for you. In a narrative, story-telling style that is much easier reading than a mathematical, economic, or statistical textbook, the author covers a whole range of interesting and informative theories that are relevant to trading and investing.
Knowing that a trader who uses the Kelly Formula to maximize return always has a 50% chance of losing 50% (or X% chance of losing (100-X)% generally) of their capital may be an eye-opener for many traders. Although this book will not tell you how to make money trading, it will generate more than a handful of useful areas of research, and get you thinking about risk management rather than entry signals.
Covering a multitude of financial, economic, and mathematical geniuses, this book has many interesting side-stories and anecdotes that are amusing, interesting and thought-provoking. The majority of this book is not strictly about trading, but all of the ideas have some application to trading and investing if you think hard and long enough.
Beat the Odds or Not, Cant Beat this Book December 26, 2005
Sreeram Ramakrishnan (Yorktown Heights, NY)
5 out of 7 found this review helpful
In a remarkably detailed not-so-easy-to-read account, Poundstone discusses very varied approaches by theorists in quanitifying (in order to be able to beat) odds/risk. While the discussion focuses initially on the work associated with gambling, it soon melds into efficient market theory, portfolio theory, meauring risk and other topics related to 'investment'. The theoretical underpinnings of some of the better known theorists/modelers/mathematicians in this field is discussed interspersed with lesser-known "behind-the-stages" stories. That approach makes the book very readable even for readers with no specific science background. However, the reader shouldn't expect a weekend-read from this book. A must-read for anyone interested in quantitative modeling, an engaging (albiet not easy) introduction for non-scientists.
Well Written and Balanced January 2, 2006
Fred Corsiglia (Abu Dhabi, UAE)
6 out of 8 found this review helpful
I wish I had the time to read in a limited number of sittings, but instead I read small segments every day. I thought the book was fascinating. Starts with some of the origins of wire services (transmitting race results for wagering where the results were not yet known), their links to organized crime (and the Daily Racing Form). and goes into the mathematical questions about maximizing wealth and utility. This book introduced me to John Kelly and Claude Shannon who were pioneers in several technologies. Towards the end, the book spends an increasing amount of time on the stock market and characters such as Rudy Giuliani, Michael Milken and Ivan Boesky. Ed Thorp is a constant throughout the book.
The writer's style is outstanding. The book is composed into a series of short chapters on a concept with a surrounding, typically non-fictional, vignette.
In addition to the Kelly criterion, there was a tremendous content of reviews of money management concepts and their (mis)application. This is one of the best books I read this year.
The only trouble with this book is it's not longer November 26, 2005
Aaron C. Brown (New York, New York United States)
6 out of 12 found this review helpful
Poundstone has unearthed so many entertaining stories and dazzling insights, it begs for a sequel. This is the best account to date of the Kelly Criterion, a simple, powerful idea for understanding risk. As far as I know, this book the only account of Kelly himself. While Shannon and Thorp have been described elsewhere, their intersection with each other and Kelly is an amazing story. Toss in some fascinating and little-known history and some well-told anecdotes and this is a book it is a joy to learn from. A little math will enhance your understanding, but it is not required.
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