How a mild-mannered mathematician beat the mob, Vegas and Wall Street.
Las Vegas 1960s: A place run by men who ordered hits over cappuccinos and made offers nobody refused. Men who were feared, and feared no one.
Well, except for one man. One man scared them more than an IRS audit. The man was Edward O. Thorp, a slightly built, soft-spoken MIT mathematician with glasses, good manners and an interest in gambling. Thorp was not a card player, but he was good with numbers. Really good. And he had a math theory about blackjack that he wanted to prove outside the MIT labs, in the very real world of Las Vegas casinos. In short, Thorp had developed what every flush-on-Friday-broke-on-Saturday gambler dreamed of: a system that shifted the blackjack odds in his favor. Because of that, Thorp would be drugged, forced to don disguises, banned from a dozen casinos, and threatened.
He would also become very, very rich, not only changing the gambling world forever, but also revolutionizing Wall Street trading and becoming one of Newport Beach’s most respected financial minds – none other than billionaire PIMCO founder Bill Gross said he owed his career to Thorp in his endorsement of Thorp’s third and latest bestselling book, “A Man for All Markets.”
But back in 1958, hundred-million-dollar trades, bestselling books, and especially taking on the mob, were as far from Thorp’s mind as his ocean-view Newport Center corner office. He had just graduated from UCLA with a Ph.D. in mathematics and figured he’d live the quiet life of an academic with his wife.
It was then that he learned of a few fellow mathematician/soldiers who had passed time in the army playing blackjack. They had written a paper purporting to have a system to maximize your chances to win. On a whim, Thorp went to Vegas to try it, using a small cheat sheet on how to bet. It didn’t work very well.
Not one to let an unsolved problem go, Thorp dug into the paper again and that’s when he realized that the army guys’ system, just like every other system at the time, made one fatal flaw: It didn’t take into account that, unlike most other games of chance, in blackjack, what happened in the hand before your hand, and the one before that, mattered.
In other words, if you roll a pair of dice and come up with a seven, there is exactly the same chance that you’ll roll a seven on the next turn, and the next, and the next. Each roll of the dice is independent.
“But in blackjack, as the cards are dealt from the deck, and therefore taken out of play for the next hand, the odds change,” explains Thorp. The odds swing back and forth, in the player’s favor or the house’s.
The problem for Thorp was that figuring out the odds for each and every scenario was seemingly impossible – or at least a monumental mathematical task. Remember, this is 1958. Computers were the size of trucks and complex calculations meant major programming feats.
Fortunately for Thorp, in 1959, he took a job teaching at MIT, which had a state-of-the-art punch card IBM 704 computer, a massive machine that also happened to be the only computer at the time that could handle complex math. So, late every night, and after teaching himself Fortran, Thorp used it to run blackjack probabilities. For more than a year.
“But I came up with the probabilities for each hand for every scenario as cards were pulled from the deck,” says Thorp. In other words, he invented counting cards and a system that, if played perfectly, tipped the odds for winning in his favor. He knew how to beat Vegas.
Now, it’s a good bet that a person who just discovered a sure-fire way to win big in Vegas would book the first plane flight to Sin City.
Thorp would lose you that bet. Because Thorp did not fly to Vegas. Thorp did not invite five of his richest friends over for a night of cards. Instead, Thorp wrote a paper called “A Favorable Strategy for 21,” published in The Proceedings of the National Academy of Sciences. He thought he’d really wow his fellow mathematicians and improve his stature in academia.
It didn’t quite work out that way. The paper got the attention of national newspapers, but instead of heralding Thorp as a math genius, people saw him as one more crackpot, albeit a smart one, with a great system to go broke. In fact, one casino spokesperson at the time said, “When a lamb goes to the slaughter, the lamb might kill the butcher, but we always bet on the butcher.”
Unless the lamb is really, really smart, and out to prove a point.
In February of 1961, a blue Cadillac rolled up to Thorp’s apartment. An older white-haired man in a long cashmere coat got out with a blonde on each arm. The man was Emanuel “Manny” Kimmel and he said he was a businessman and the girls were his nieces.
What he didn’t tell Thorp was that he was a former illegal bookie and gambling ring operator in New Jersey with Mafia ties. Thorp, being an unworldly academic, didn’t guess it. “I was pretty naïve,” laughs Thorp. But he was also intrigued. “And I wanted to prove my theory.”
Kimmel had an offer: He would stake Thorp in an “applied research” trip to Vegas. Thorp could keep 10 percent of the winnings for his trouble.
“He wanted to go with $100,000,” says Thorp. That’s about $815,000 in today’s money, by the way. “That kind of money made me nervous, so we settled on $10,000,” says Thorp. Which still made him nervous since it was more than he made in a year.
So they hit Reno, then Vegas, with $10,000 to test Thorp’s game theory. And they won. A lot. In fact, after a few days in Vegas, Thorp was up $13,000 to $106,000 in today’s money.
Over the next few years, Thorp began using Vegas as his personal ATM. He’d fly out when he wanted a little extra cash for a new car or home repair. Soon enough, of course, the casino bosses were onto Thorp. At first they thought he was cheating, but soon enough they became just plain terrified of him – this lamb is very butcher-like. Weird stuff started happening to Thorp, like coffee that knocked him out, malfunctioning car accelerators, threats, that sort of thing. Thorp began using disguises – contacts, beards, weird shirts and hats.
Then, in 1962, he wrote a bestselling book, “Beat the Dealer,” which taught the world how to count cards and take Vegas. Unfortunately for us, Vegas bosses read the book too. You can thank Thorp for seven-deck shoes, frequent shuffling and rules banning card-counting.
For his part, Thorp tired of Vegas. Besides, by this time he was a professor at UC Irvine and had turned his theory to the world’s biggest casino: Wall Street.
Because of his success at blackjack and “Beat the Dealer,” Thorp and his wife finally had a little money. Thorp decided he’d do what everyone else did: invest in the stock market. So one summer he read a dozen books on investing and bought some stocks.
“But the first investments worked out quite badly,” says Thorp, with his signature humility.
The key problem was that he was following other investors’ strategies, says longtime associate Thomas Rollinger, a man who thinks so much of Thorp that he named his son after him. “Ed firmly believes in thinking for oneself, and lives this creed,” says Rollinger. “He forges his own path and never believes an ‘expert’ on faith or a strong story. He instead chooses to rely on scientific fact, data, actual evidence when available, but at the very least, his own assessment.”
Aware that he had strayed from this winning formula, the next summer Thorp attacked his book reading with his signature probing and skeptical approach. He came across this thing called a call option, which lets you buy a particular stock at a certain price before a future date. In the late ’60s, these were considered crazy risky. And they were priced erratically.
“I saw that if you bought both the right option and the underlying stock in the right mix, you could remove risk and increase your ability to make money,” says Thorp. “I realized that you could extract money systematically.”
He put his math brain to work and, along with another UCI professor, Sheen T. Kassouf, came up with a formula he liked. And just like when he flew to Vegas with $10,000 and a system, he gave his new formula an “applied research field test.”
This time, there were no death threats, no drugged coffee, no men in cashmere coats. Just a lot of winnings. In fact, the formula worked so well that Thorp began managing money for his friends and colleagues. The deans, professors, even the chancellor’s secretary became clients. And for good reason: A few years after Thorp came up with his formula, a pair
of economists worked out the same formula independently, published it, and won a Nobel Prize.
Thorp founded Princeton/Newport Partners, left teaching, and became a very, very wealthy man, making his friends and clients a ton of money along the way. For 20 years, Princeton/Newport was one of the most successful investment firms in the country, averaging annual returns nearing 20 percent. But in the late 1980s, members of the Princeton, New Jersey, office were convicted on a scheme to avoid federal taxes. Thorp was never implicated or charged and many of the others’ charges were overturned on appeal, but it killed the business, so Thorp founded his own, independent financial firm, which continues to this day.
Thorp also co-wrote a book with Kassouf, “Beat the Market: A Scientific Stock Market System,” foretold the entire Bernie Madoff debacle (he saved a few friends from losing their life savings), and became known as the godfather of quantitative finance, which revolutionized the stock market.
“I think Ed’s true brain-power and brilliance are still flying under the radar,” says Rollinger. “I think he’s up there with Isaac Newton, Richard Feinman, Albert Einstein. He’s a living legend, and it goes a lot deeper than blackjack and hedge funds.”
Thorp is now 84, but every bit as sharp and engaged as ever. He says it’s because, just like blackjack and Wall Street, he has taken a “systematic approach” to his health. A lifelong runner of marathons, Thorp still walks up to 15 miles a week and spends a few hours a week in the gym. He also travels a lot and stays engaged in both the gambling and financial world to keep his mind nimble.
And, in these unprecedented and uncertain times, Thorp’s mind might have to be at its best, because he says that with the drumbeat for deregulation thumping louder than ever and an administration stacked with businessmen and multi-millionaires, look for the next bubble-and-burst scenario to play out in the not-too-distant future.
The only question, says Thorp, is which sector implodes the market this time around – housing, tech, oil or some other industry. That will depend on which sector the guys in charge believe most benefits them, says Thorp. In other words, the house always wins.
Unless you’re Thorp, that is. Because in the end, only one thing is certain: Thorp will come out a winner. You can bet on it.