How to Win at Everything—Scientifically

In 1961, Ed Thorp, a young mathematician from MIT, joined forces with Emmanuel Kimmel, a semi-legitimate New York businessman, to undertake a financial adventure. The two took a trip to Reno, Nevada, to play blackjack using previously unheard-of methods for card-counting and money management. The stakes were high: Kimmel had committed $10,000 to the scheme (his initial pledge was ten times that, but Thorp preferred risking a more modest sum). The two men played cards in a series of casinos, and they were kicked out of many for being too successful. At least one casino’s dealers resorted to cheating to counteract the surprising good luck of this unlikely pair of gamblers. By the time Thorp and Kimmel wound up their excursion and returned to the East Coast, they had more than doubled their money, to $21,000. Their profit would have been still greater had not Kimmel, betting recklessly, hit a terrible losing streak only nights before their departure.

Kimmel and Thorp’s trip to Reno is but one of many similar tales related in the new book Fortune’s Formula: The Untold Story of the Scientific Betting System That Beat the Casinos and Wall Street, by William Poundstone, published by Hill and Wang. The story begins with the development of the money-management system Thorp and Kimmel used on their trip. It was born at AT&T’s Bell Laboratories, went on to use in seedy casinos, and had its greatest successes in the world of investment banking. The so called “Kelly formula,” first published in 1956 by John L. Kelly, a colorful Texan fond of guns, horse racing, college football, and physics, purports to tell gamblers exactly how much to wager on a given bet. Essentially it comes down to a ratio meant to compare the individual gambler’s edge to the general odds on a given bet, linking the size of the bet or investment to both the bettor’s advantage and the size of his bankroll. The amount of money wagered using the Kelly system increases automatically as winnings (hopefully) grow. Experience, like Thorp and Kimmel’s triumphs in Reno, and calculus both strongly support the notion that using Kelly’s formula provides the maximum long-term rate of growth for anyone investing in risk, while simultaneously shielding that person from utter ruin.

Readers hoping to learn a get-rich-quick scheme from the book may be dissatisfied, though. The cautious, modest Thorp—who hesitated to purchase a luxurious house until he was fabulously wealthy—himself described his financial-growth strategy as “getting rich slow.” And the book makes it clear that the Kelly formula alone is not enough to guarantee success. While you can’t lose all your money using it, you can lose most of it. Furthermore, as the Reno trip shows, you often must combine the formula with some other clever strategy, like card-counting, to guarantee a sufficient edge. The investors who later used Kelly-based techniques for managing their money, Thorp among them, had also mastered all the other intricacies of hedge funds. Nevertheless, the book makes a compelling case for the Kelly formula’s extraordinary efficacy.

Beyond the details of the “Scientific Betting System That Beat the Casinos and Wall Street,” Fortune’s Formula offers a fascinating illustration of an intersecting world of academics, business, and crime. Ed Thorp is the prime example, an MIT-turned-U.C. Irvine math professor who teamed up, albeit unknowingly, with members of New York City’s organized-crime world to make a killing at the blackjack tables and then later founded and managed one of the most successful investment firms of the 1980s. Paul Samuelson, a Harvard economist and the uncle of current Harvard President Lawrence Summers, appears straddling the domains of university and brokerage to relentlessly condemn the Kelly formula as a fraud. And Claude Shannon may provide the most interesting and enigmatic of Poundstone’s portraits. He was the genius who founded the field of information theory, an underpinning of all modern computers, and then managed his own stock portfolio to achieve a greater rate of return over 30 years than the investment whiz Warren Buffett’s Berkshire Hathaway firm.

Some other names crop up in the book too. Former New York City Mayor Rudolph Giuliani, at the time a U.S. attorney, plays a prominent role in Poundstone’s discussion of the investment atmosphere of the 1980s, cutting a figure self-consciously modeled on the Prohibition-era supercop Eliot Ness and focused more on cleaning up Wall Street than on anything else—except for his political future. Indeed, Fortune’s Formula is, for anyone not already deeply familiar with the world of finance, an illuminating history of recent fights over regulation and insider trading, and of the spectacular failures of several investment firms at the turn of the twenty-first century. It is unlikely that many readers will know in advance just how close some financiers have been to the spheres of organized crime, high-stakes politics, and advanced math and science. Poundstone reveals much about this.

Fortune’s Formula is written engagingly, in places taking on the suspenseful characteristics of a nail-biting mystery novel, and with a cast of characters varied, vibrant, and vicious. The narrative flow is at times diverted into interesting but tangential topics like a chilling but awkwardly related “Orwellian” statement that Giuliani would later make as mayor. But the book’s occasionally meandering course may constitute part of its appeal, too, as it goes out of its way to highlight particularly intriguing aspects of the personalities it portrays. The one thing about the book that may disappoint some is that it doesn’t quite offer the infallible gambling advantage its readers might hope for. This reader, at least, remained convinced at the book’s end that the only sure bet is the one not made.

—Alexander Burns, an undergraduate at Harvard College, is a frequent contributor to AmericanHeritage.com