Fortune's Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street

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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Book Summary Information

Author: William Poundstone
Edition: Paperback
Published: 2006-09-19
ISBN: 0809045990
Number of pages: 400
Publisher: Hill and Wang

Book Reviews of Fortune's Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street

Book Review: It takes exceptionally smart people to make truly massive blunders
Summary: 5 Stars

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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All Fortune's Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street Customer Reviews

Summary of Fortune's Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street

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

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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