Fortune’s Formula: The Untold Story of the Scientific Betting System
Fortune’s Formula: The Untold Story of the Scientific Betting System
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 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
User Ratings and Reviews
4 Stars Quick, entertaining, informative
FF is a gentle introduction to information science and the ’science’ of gambling and the stock market. Well worth the read. Fans of WP might be interested to know: FF is something of a departure from WP’s earlier books, which are generally both rigorous and challenging treatments of their subject matter. FF is altogether in the popular science mode — light on rigor and challenge. Whereas WP’s earlier books took me some time to read and digest, I dispensed with FF in an afternoon. All in all, though, a very pleasurable afternoon.
4 Stars An interesting history, no math
Poundstone does not know from math, but the book’s portraits of Thorp and Shannon (two foundational figures in different fields) are quite interesting. What is also interesting is his discussion of “academic dogma vs reality”, which shows that economics is much more “social” than a “science” (with scary consequences for our health and wellbeing, since our fearless leaders (eg, Bernanke and Summers) are academic economists.
The Kelly formula itself, while interesting, is of dubious utility in the stock market, except as a philosophical guideline.
5 Stars Kelly formula for calculating investment bets
I picked up this book because Mohnish Pabrai, the author of The Dhandho Investor, recommended it. The author describes the Kelly Formula that was developed by John Kelly at Bell Labs in New Jersey and applied by the individuals featured in the book. The formula calculates the optimal fraction of one’s bankroll to bet on a favorable bet.
Edge/Odds = Fraction of one’s bankroll to bet each time
For example, if you have a 50% chance of winning $100, and 50% chance of losing $50, how much do you bet? According to the formula, your edge = (50% x $100) + (50% x - $50) = $25. The odds are what you win, which in this case is $100. So the Kelly Formula is $25/$100 = 25%. This means that under this scenario, you bet 25% of your bankroll.
This is an interesting book and I recommend it to other readers.
- Mariusz Skonieczny, author of Why Are We So Clueless about the Stock Market? Learn how to invest your money, how to pick stocks, and how to make money in the stock market
4 Stars Fortune’s Formula: The Untold Story…
Very interesting history of how brilliant people apply their insight & knowledge to beating the casinos and Wall Street. Amazing how simple some of the ideas are. Shows that in many cases there is little difference between betting and investing.
4 Stars Gamblers, gangsters and scientists
This is a well-written and exciting account of the ‘Kelly criterion’ as used in gambling and investing, and the story about the scientists and gangsters that invented it and put it to use.
I enjoyed reading this book very much and recommend it to anyone interested in either gambling or investing. As a scientist / investor myself I found it to be a most refreshing read.
You will not learn how to apply the Kelly criterion from reading this book but it will inspire you to pursue the subject.
Filed under: Personal Finance Book Reviews