Top 3 Lessons for Investors from A Man for All Markets
Learn life lessons from this legendary investor
From Las Vegas to Wall Street with Edward Thorp
Edward O. Thorp, born in Chicago in 1932, grew up in California and graduated from UCLA. In 1967, Thorp published "Beat the Dealer," a book that described a system for beating the market. The book became a bestseller and inspired many people to start playing blackjack.
Thorp then parlayed his success in blackjack to a new kind of casino... The new derivatives market. He was trading options off based off the famous Black-Scholes model before Black and Scholes published their model.
Thorp’s first hedge fund was Princeton Newport Partners. They never had a down year. And they compounded money at 19% annually for nearly 2 decades - slaying the S&P 500.
Edward Thorp's second book "Beat the Market" explained how we systematically beat the market as a hedge fund manager. Another good book that we'll review later... But "A Man for All Markets" is probably the best book by Thorpe. This book not only covers investing and gambling strategies. Thorp conveys his outlook on life... And I have to say, he's one of the most balanced people out there.
With his intelligence, he likely could have been a billionaire. But he decided his life wouldn't change much if he made more money. And he found more enjoyment in leisure activities and spending time with his wife Vivian.
But this book is still full of investing wisdom.
Wait to Bet until You Have an Edge
Before making any investment, you should know why you're making a bet with a positive expected value.
Thorp was one of the most successful blackjack players because he knew his edge. He played the proper strategy, but that alone isn't enough to gain an edge at the blackjack tables. Thorp figured out that if he counted cards and bet more when there were more high cards than normal still yet to be dealt he had an edge.
Individual investors can do the same thing in the markets if they study the markets and look hard enough. That's what we do here at barbellalpha.com. We look for edges to make concentrated bets and take home surefire money.
It's all about knowing your circle of competence. In the financial markets, there are thousands of ways to make money. It's impossible to be great at all those ways.
But most people are not like us. They aren't putting in the time to learn strategies dealing with options, arbitrage, and other asymmetric bets. Those people, Thorp says, should just buy and hold stocks. Then let the power of compounding work for you.
I agree. This is what I tell most people to do. If they don't want to spend the time to learn and then follow the markets, they should just buy a low-cost index fund.
Wait For the Fat Pitch
The key to a successful investment strategy is to wait for the fat pitch. If you don't like the prices the market is offering, you don't have to do anything. Successful investors also know when to sit in cash.
The term "fat pitch" refers to companies whose shares trade at a discount compared to their intrinsic value. A fat pitch can occur because the market does not recognize the potential risk associated with the company. Or it could mean that the company has limited competition.
But the fat pitch could also be a dislocation in the market. One example I can think of from Thorp's history is the SPAC market in 2008. During the Great Financial Crisis, even SPACs got beaten down. SPACs, commonly known as black check companies, hold just one asset: cash. With that cash, they look to bring a private company public. And if they don't, the investors receive the cash back.
These SPACs were trading at such a big discount they were yielding about 12% annually until they were forced to return cash to investors.
Thorp backed up the truck and bought these investments. This is one of the few sure bets in the stock market.
While it's not a 100x return investment that will make a legendary investor, it's a bet that will pad your track record over a long period of time.
Size your Positions Appropriately
One of the most important concepts from Edward O. Thorp's bag of tricks is the Kelly Criterion. This is something many gamblers follow to make sure they can stay in the game.
I'm not going to give the exact formula... Here's the important concept:
The less certain of the payoff you are, the smaller the bet size you should make. That will allow you to stay in the game until that bet pays off.
So if you're buying out of the money calls that expire shortly, you should not put 50% of your capital in that play. It's a low probability outcome. But it's one that if you can stay in the game for long enough, you can hit some winners and come out ahead.
But if you're looking at a sure bet, like the SPAC example from above, you can bet a lot. Because you're certain it will pay off. This is important to remember when making investments.
You always want to have the capital to continue playing. Do not blow up your account.
Conclusion
In conclusion, even when Thorp isn't specifically giving investment advice, we can learn ways to make excess returns from him.
It's important to know your circle of competence... And when you get the fat pitch, jump on it. But don't overplay your hand.
But there's so many more great life lessons in this book. It's one every person should read... Whether or not they are a serious investor. Thorp's outlook on life is unique amongst people that have garnered the success of his.
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