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A review by nghia
Fortune's Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street by William Poundstone
2.0
This book has a pretty misleading title. It purports to be the untold story of a scientific betting system. And you do get that. But it turns the "story", such as it is, it pretty slight. The vast majority of the book is taken up with totally unrelated side stories and anecdotes. These add character and color -- I suppose -- but they have literally nothing to do with the Kelly Criterion.
If you want a scattershot of brief stories from people even 3rd-degree connected to the Kelly Criterion, then you'll find a few interesting stories about the mob-owned parking lots turning into Warner Brothers, about Claude Shannon's personal investing, about Long-Term Capital Management's collapse, about card counting in Las Vegas casinos and so on.
The Kelly Criterion itself gets surprisingly short shrift. The academic debate appears to have lasted only about 10 or 15 years and has been quiescent since the 1970s. 95% of academics think the Kelly Criterion is somewhere between wrong & useless. And 5% of academics (who are largely not economists) think it is not just useful but nearly mandatory. And those positions haven't shifted in decades.
The Kelly Criterion's application to betting is briefly detailed but little more is said than, "Yep, Ed Thorp used it while betting on blackjack and some horse racing bettors in Hong Kong said they use it". But it seems that the real success there was the card counting and horse betting systems...the Kelly Criterion was not the deciding factor.
There's a long story about the collapse of Long Term Capital Management. It takes several chapters. It has nothing to do with the Kelly Criterion except to seemingly say, "If they had used the Kelly Criterion they wouldn't have collapsed. Oh, except using the Kelly Criterion would have undermined their entire business model so the company wouldn't have existed in the first place." In addition to being seemingly irrelevant, it is hardly a ringing endorsement of the Kelly Criterion. What's more, it isn't clear that the Kelly Criterion would have saved them. LTCM didn't go to $0. They fell by 50% and then competitors saw blood, stopped rolling their debt, customers starting redemptions, and so on. It seems like the same thing could happen with the Kelly Criterion -- after all, nothing in the Kelly Criterion prevents you from losing 50% in a matter of days. You could easily see the same liquidity spiral while using the Kelly Criterion.
Likewise, there's a fairly long section about Claude Shannon's alleged lifetime investing success. Something like 80% of his holdings were in just 3 stocks. Which hardly seems compatible with the Kelly Criterion. Leaving aside the dubiousness of relying on after-the-fact self-reported investing gains.
I found the part of the book about the academic arguments the most interesting part. Unfortunately it takes until nearly the 50% mark for that happen. I had nearly given up by that point. Here are some examples to show what I mean about colorful examples of people who are only very tangentially related to the Kelly Criterion:
The chapter "Eternal Luck" is about John Koonmen. He worked in Lehman Brother's Tokyo office. He joined Amber Arbitrage. He squabbled with his boss over splitting profits and left. He founded Eifuku Master Trust. Over 7 trading days in 2003, Eifuku Master Trust lost 98%. He closed the fund and went to Africa to photograph wildlife.
What's the connection? It is just a random story of a hedge fund that blew up. The Kelly Criterion is nowhere in the picture.
Likewise, there's a long section about the rise of Rudy Guiliani, use RICO to prosecute mobsters and (eventually) Michael Milken (the junk bond king). What's the relationship to anything related to the Kelly Criterion? It works like this: Ed Thorp is a big believer in the Kelly Criterion. His hedge fund needed a broker, so they chose Michael Milken. That's enough of a connection to have several chapters about Michael Milken, who in no way shape or form cared anything about the Kelly Criterion.
Ultimately, the book is largely about Ed Thorp because he's the person who seems to have used the Kelly Criterion the most. (Or at least talked about it the most.) Nowadays should we just read Ed Thorp's own book about himself ("A Man For All Markets")?
If you want a scattershot of brief stories from people even 3rd-degree connected to the Kelly Criterion, then you'll find a few interesting stories about the mob-owned parking lots turning into Warner Brothers, about Claude Shannon's personal investing, about Long-Term Capital Management's collapse, about card counting in Las Vegas casinos and so on.
The Kelly Criterion itself gets surprisingly short shrift. The academic debate appears to have lasted only about 10 or 15 years and has been quiescent since the 1970s. 95% of academics think the Kelly Criterion is somewhere between wrong & useless. And 5% of academics (who are largely not economists) think it is not just useful but nearly mandatory. And those positions haven't shifted in decades.
The Kelly Criterion's application to betting is briefly detailed but little more is said than, "Yep, Ed Thorp used it while betting on blackjack and some horse racing bettors in Hong Kong said they use it". But it seems that the real success there was the card counting and horse betting systems...the Kelly Criterion was not the deciding factor.
There's a long story about the collapse of Long Term Capital Management. It takes several chapters. It has nothing to do with the Kelly Criterion except to seemingly say, "If they had used the Kelly Criterion they wouldn't have collapsed. Oh, except using the Kelly Criterion would have undermined their entire business model so the company wouldn't have existed in the first place." In addition to being seemingly irrelevant, it is hardly a ringing endorsement of the Kelly Criterion. What's more, it isn't clear that the Kelly Criterion would have saved them. LTCM didn't go to $0. They fell by 50% and then competitors saw blood, stopped rolling their debt, customers starting redemptions, and so on. It seems like the same thing could happen with the Kelly Criterion -- after all, nothing in the Kelly Criterion prevents you from losing 50% in a matter of days. You could easily see the same liquidity spiral while using the Kelly Criterion.
Likewise, there's a fairly long section about Claude Shannon's alleged lifetime investing success. Something like 80% of his holdings were in just 3 stocks. Which hardly seems compatible with the Kelly Criterion. Leaving aside the dubiousness of relying on after-the-fact self-reported investing gains.
I found the part of the book about the academic arguments the most interesting part. Unfortunately it takes until nearly the 50% mark for that happen. I had nearly given up by that point. Here are some examples to show what I mean about colorful examples of people who are only very tangentially related to the Kelly Criterion:
The chapter "Eternal Luck" is about John Koonmen. He worked in Lehman Brother's Tokyo office. He joined Amber Arbitrage. He squabbled with his boss over splitting profits and left. He founded Eifuku Master Trust. Over 7 trading days in 2003, Eifuku Master Trust lost 98%. He closed the fund and went to Africa to photograph wildlife.
What's the connection? It is just a random story of a hedge fund that blew up. The Kelly Criterion is nowhere in the picture.
Likewise, there's a long section about the rise of Rudy Guiliani, use RICO to prosecute mobsters and (eventually) Michael Milken (the junk bond king). What's the relationship to anything related to the Kelly Criterion? It works like this: Ed Thorp is a big believer in the Kelly Criterion. His hedge fund needed a broker, so they chose Michael Milken. That's enough of a connection to have several chapters about Michael Milken, who in no way shape or form cared anything about the Kelly Criterion.
Ultimately, the book is largely about Ed Thorp because he's the person who seems to have used the Kelly Criterion the most. (Or at least talked about it the most.) Nowadays should we just read Ed Thorp's own book about himself ("A Man For All Markets")?