Fortune's Formula: The Untold Story of the Scientific Betting System that Beat the Casinos and Wall Street by William Poundstone
[Read in August of 2009 but was delayed in writing the review.]
I absolutely loved this book, in fact I more or less devoured it as it involved three topics that I find very interesting:
- Computing history
- Information Theory
- Investing & Quantitative Finance
How can a book involving these three topics be anything but good!
OK, enough gushing, the book is essentially about the following three people:
- Claude Shannon: Bell Labs super-genius most famous for creating the field of Information Theory but who also invented the use of boolean binary logic in digital computers, and made material contributions to the fields of Mendelian genetics, cryptography, and computational logistics.
- John L. Kelley: Bell Labs scientist famous amongst geeks for programming an IBM 704 to sing the song Daisy Bell which inspired HAL-9000's song at the end of the movie 2001: A Space Odyssey. Kelly is also famous for using Shannon's Information Theory to create the Kelly Criterion method for optimal betting or investing given inside information.
- Edward O. Thorpe: M.I.T. professor famous for writing the book Beat the Dealer which proved card counting could be used to win at Black Jack. Thorpe is also famous for pioneering the use of computers in hedge fund investing (a.k.a quantitative finance). Thorpe's fund, Princeton Newport Partners, achieved an impressive annualized return of 15.1% over its 19 year duration.
The story more or less goes thusly:
- Shannon invents Information Theory
- With Shannon's help Kelley uses Information Theory to create the Kelly Criterion for determining an optimal betting strategy given inside information.
- After meeting at M.I.T., Shannon and Thorpe research ways of using wearable computers to win at roulette. Thorpe goes on to use the Kelly Criteria to first make optimal bets while card counting and later make profitable investments for his hedge fund.
The book focuses on how the interaction between these three men gave rise to much wealth. Along the way Poundstone discusses related topics such as Efficient Market Theory, the Random Walk Hypothesis, and statistical arbitrage. Poundstone includes just enough mathematics to make the story interesting to technical readers without alienating other audiences.
It must be noted that the book offers a much richer story including the influences of organized crime at various stages of history.
All in all, a great book that I highly recommend to anyone interested in these topics.
