The House Always Wins. Then He Came Along
RACHEL MARTIN, HOST:
The card game blackjack has been around a long time. But until Ed Thorp came along, no one had figured out how to beat it. Thorp has just written a book called "A Man For All Markets" about how he did just that. He beat blackjack and then he went on to transform the world of investing. Jacob Goldstein of our Planet Money podcast has the story.
JACOB GOLDSTEIN, BYLINE: For hundreds of years, really smart people have tried to figure out how to get an edge in casino games. And again and again, they've discovered that in the long run, the house always wins. But in 1959, when Ed Thorp was a math geek just out of grad school, he realized that blackjack is fundamentally different than other casino games.
EDWARD THORP: Most of the games, whatever happens on one trial or one play of the game doesn't have any influence on what's going to happen next.
GOLDSTEIN: If the roulette wheel comes up red on one spin, the odds of whether it's going to come up red on the next spin don't change. Thorp saw that blackjack, also known as 21, was different. At the time, the dealer dealt from the same deck for several hands in a row. That meant that if, say, you got an ace in the first hand, you were in fact less likely to get an ace in the next hand.
THORP: I realized that in a minute or two that if cards were used up during the play of the game, the odds would shift back and forth - sometimes for the casino, sometimes for me.
GOLDSTEIN: It took him about a year to do all the calculations, but he did it. He figured out how to win.
Ed Thorp, you're the first person to develop a scientific system to beat the casinos at blackjack. What are you going to do now?
THORP: I said - well, I'm going to publish this in a scientific journal of one sort or another.
GOLDSTEIN: Why were you more interested in publishing than in making money?
THORP: I wasn't money-oriented basically at all. I thought that teaching in the university would be a great life.
GOLDSTEIN: And did this seem like a step in that direction? Like...
THORP: Well, I didn't think of it that way. I just thought, here's something that's going to amaze you guys. You haven't...
GOLDSTEIN: (Laughter) It's like doing a magic trick or something.
THORP: Right, exactly.
GOLDSTEIN: Yeah, yeah.
The article was published in a scientific journal, and it became something of a popular sensation. And then one day, a blue Cadillac pulled up outside Thorp's apartment.
THORP: And then this white-haired, kind of short, elderly man in a long cashmere coat got out.
GOLDSTEIN: The man offered to bankroll a trip to the casinos. They flew to Reno, Nev., and more than doubled their money in a few days of gambling. Thorp made more trips, kept winning. And eventually, he thought - if I can beat the casinos, maybe I can go bigger. Maybe I can beat the stock market.
THORP: So I made a few investments, and they worked out terribly.
GOLDSTEIN: Then, Thorp discovered call options, which give an investor the right to buy a particular stock at a set price. As he did with blackjack, he thought about the math and did a lot of calculations, in this case, to figure out what the right price of an option should be.
THORP: And I got a really neat formula. So I said I like this formula. It looks right to me. I'm going to try it out.
GOLDSTEIN: It worked. Thorp started making consistent profits. A few years later, two economists came up with the same formula. Their work went on to win the Nobel Prize. Thorp started an investment firm. And for almost 20 years, it was one of the most consistently successful firms in the country. He says his investments were patterned on the approach he took to blackjack.
THORP: I'm looking at it in a new way. If you bring in more information, what seemed unbeatable may become beatable.
GOLDSTEIN: Thorp's firm shut down in the 1980s after a few people there got into legal trouble. Thorp himself was never charged. Thorp's out of the investing business now. But the investing business is now full of people who are trying to be like Ed Thorp, trying to use math and computers and to find new ways of looking at markets.
Jacob Goldstein, NPR News. Transcript provided by NPR, Copyright NPR.