School Mistreated Edward Thorp

A Man for All Markets: From Las Vegas to Wall Street, How I Beat the Dealer and the Market, by Edward Thorp, begins with some horror stories about school (bolds added):

Just after I turned five I started kindergarten at Dever Grammar School in northwest Chicago. I was immediately puzzled by why everything we were asked to do was so easy. One day our teacher gave us all blank paper and told us to draw a copy of an outline of a horse from a picture she had given us. I put little dots on the picture and used a ruler to measure the distance from one to the next. Then I reproduced the dots on my piece of paper, using the ruler to make the distance between them the same as they were on the picture and with my eye estimating the proper angles. Next, I connected up the new dots smoothly, matching the curves as well as I could. The result was a close copy of the original sketch.

My father had shown me this method and also how to use it to draw magnified or reduced versions of a figure. For example, to draw at double scale, just double the distance between the dots on the original drawing, keeping angles the same when placing the new dots. To triple the scale, triple the distance between dots, and so on. I called the other kids over, showed them what I had done and how to do it, and they set to work. We all handed in copies using my method instead of the freehand sketches the teacher expected, and she wasn’t happy.

A few days later the teacher had to leave the room for a few minutes. We were told to entertain ourselves with some giant (to us) one-foot-sized hollow wooden blocks. I thought it would be fun to build a great wall so I organized the other kids and we quickly assembled a large terraced mass of blocks. Unfortunately my project totally blocked the rear door—and that was the one the teacher chose when she attempted to reenter the classroom.

The last straw came a few days later. I sat on one of the school’s tiny chairs meant for five-year-olds and discovered that one of the two vertical back struts was broken. A sharp splintered shard stuck up from the seat where it had separated from the rest of the strut, so the whole back was now fragilely supported only by the one remaining upright. The hazard was obvious, and something needed to be done. I found a small saw and quietly cut off both struts flush with the chair’s seat, neatly converting it into a perfect little stool. At this, the teacher sent me to the principal’s office and my parents were called in for a serious conference.

Then, during high school, he was cheated:

With ten weeks to go before the American Chemical Society exam, as I practiced taking old tests, I was scoring 990 or more out of 1,000. I told Mr. Stump I was ready to try the ten he had held back. I got over 99 percent on the first two of these as well, so we went directly to the exam from the previous year, on which I did equally well. I was ready.

On the day of the exam my father drove me twenty miles to the El Camino Junior College, where I followed the crowd among the one-story barracks-like buildings to the test room. We had been told that slide rules would be allowed for the first time this year but that they weren’t necessary. As an afterthought I brought along a ten-cent toy slide rule—all I felt I could afford—thinking I could always do a quick rough check of my calculations if I had any extra time.

As I worked through the test I knew every answer. But then the last section of the test was distributed. This part of the exam required many more calculations than I could do by hand in the time allowed. My cheap tiny slide rule was worthless. Out came the full-sized well-machined slide rules all around me. Surprise! Slide rules were not merely optional—they were necessary for anyone who wanted to win. There was no credit given for showing the correct method, only credit for a numerical answer, to a specified level of “slide rule accuracy.” I was sickened by the realization I would likely not place high enough to get the scholarship I needed and unhappy with myself for not preparing by purchasing a hard-to-afford top-of-the-line slide rule. It seemed so unfair to convert a test about chemistry into one about slide rule arithmetic.

Then in college, at U.C. Berkeley, he was cheated again:

The [chemistry] course was taught by a famous professor, and we were using his book. As he was then preparing a revision, he offered 10 cents per misprint to the first student to report it. I set to work and soon brought him a list of ten errors to see if he would pay. He gave me my dollar. Encouraged, I came back with a list of seventy-five more mistakes. That netted me $7.50 but he wasn’t happy. When I returned a few days later with several hundred he explained that they needed to be errors, not mere misprints. Despite my objections, he disqualified nearly all of them. This unilateral retroactive change in the deal, which I would later encounter often on Wall Street, done by someone for their benefit just because they could get away with it, violated my sense of fair play. I quit reporting additional corrections.

And again, in the same class:

As the semester wound to a close, I had missed only a single point out of the hundreds given out for the written exams and the lab work, ranking me number one. After my unfortunate experience with the chemistry exam in high school, this was vindication. Part of our grade came when we were asked each week to chemically analyze a sample that was not known to us. After hearing that some students might sabotage others by secretly changing these unknowns, I made a practice of holding back part of mine so that, if this were done to me, I could prove that I had correctly analyzed whatever I had. On the very last sample given us to evaluate that semester, I was told I got it wrong. I knew better, and to prove it I asked that the part I had saved be tested. The decision on my appeal was left to the teaching assistant for my lab sections, who refused to act. The points I lost caused me to end the term in fourth place rather than first. Outraged, I did not enroll in chemistry the second semester and changed my major to physics. Thus I missed organic chemistry, the study of carbon compounds, and the basis for all living things. It is fundamental for biology.

My own experience in school was similar. For example, in college, I got a math problem correct on a test. The professor marked it wrong because he wasn't very clever and didn't understand the steps of my solution, and he apparently ignored my final answer which was correct. I met with the professor and taught him how to do the problem my way. He agreed that my method worked and my answer was correct. He then refused to award me any points for that problem, claiming he had a policy against changing grades retroactively (regardless of his own errors, apparently). He told me that losing points didn't matter because, if I scored high enough on the rest of the course, I could still get an A. (Of course it mattered: losing the points increased how well I'd have to do on future work to still get an A, and put me at greater risk of a lower grade.)

I also wrote more comments on the book.

Elliot Temple | Permalink | Messages (0)

I Liked Edward Thorp's Book: A Man for All Markets

Comments on A Man for All Markets: From Las Vegas to Wall Street, How I Beat the Dealer and the Market, by Edward Thorp. Bold formatting is added by me.

The professor, the son of a famous physicist, was himself a mediocrity. Because he was insecure and afraid of questions from the class, he copied his lectures from a stack of note cards onto the board, turning his back to the class to discourage interaction. Then we recopied them into our notebooks. He had been doing this for years, and the content seldom changed. This seemed stupid to me. Why not just hand out copies so we could read them in advance and come to class with intelligent questions? Of course, he was afraid someone might ask him a question he couldn’t answer.


By the time I met with the professor in his office to apologize [for criticizing his bad teaching], I realized I had behaved stupidly and rudely, and told him truthfully that what I did was improper and I regretted my actions. But there was still the more serious matter of what I had said about his teaching. I had damaged his self-esteem. He would never forgive this unless he felt I retracted what I had said. My own values and sense of self-worth made me unwilling to grovel and tell lies, despite the personal stakes. I had to find another way. I explained that I had come to realize that his teaching methods were unique and that students, though they may not always appreciate it, rarely encounter a professor of his caliber. What I said was true but allowed more than one interpretation. He picked the one I expected him to choose. He was beaming when I left, my career was saved, and I would become a better-behaved and somewhat more mature person.

Misleading people while making technically true statements is a silly game. I don't think it's honest.

Dominique Francon does something similar in her columns praising Howard Roark in The Fountainhead (the public reads them negatively).

While I was at UCLA, my PhD thesis adviser, Angus Taylor, suggested that I send some of my mathematical work to a well-known California mathematician for his comments. I got no response. But eleven months later at a Southern California meeting of the American Mathematical Society, Taylor and I heard the great man talk. The subject was my discovery, in detail, presented as part of his original work, and it was also about to appear under his name in print, in a well-known mathematical journal. Both of us were stunned. Taylor, who would later become academic vice president of the entire University of California system, was an ethical and experienced mathematician to whom I looked for guidance, but he didn’t know what to do. So neither of us did anything.

Academia is full of frauds.

When the screening committee received my abstract, their near-unanimous reaction was to reject it. I learned this later from John Selfridge, a number theorist whom I had known at UCLA and a member of the committee. For a while, he held the world’s record for finding the largest known prime number. (A prime is a positive whole number divisible only by itself and one. The first few are 2, 3, 5, 7, 11, 13…) Fortunately, Selfridge persuaded them that I was a legitimate mathematician and that if I said it was true, it likely was.

Why would the committee reject my talk? Professional mathematicians regularly receive claims that the sender has solved some famous problem, claims that almost always turn out to be from cranks, from the mathematically uneducated unaware of what’s already been done, or that include proofs containing simple errors....

... obviously, if the casinos could be beaten they would either change the rules of the game or go out of business. No wonder the committee was inclined to reject my abstract. Ironically, their reason for doing so—that mathematicians had apparently proven that winning gambling systems were impossible—was my strongest motivation for showing it could be done.

The academic screening committee was full of frauds. They didn't review the ideas, they just assumed there were simple errors. And they never changed their mind about judging math by reputation, they just changed their judgement of Thorp's reputation after Selfridge vouched for Thorp.

This trip taught me that while playing well, even with experts to warn me of dirty dealing, I could no longer openly win a significant amount. On future visits, I would need to change my appearance, be low-key, and generally avoid drawing attention to myself. Mickey MacDougall told the gaming control board that he saw more cheating in Nevada casinos while watching my eight days of play than he had seen in all his previous five years of working for the board. After his damning report he was never again asked to consult by them.

The Nevada gaming control board was full of fraud (in 1962). They turned a blind idea to casinos defrauding customers with methods like using dealers who cheat when shuffling and dealing. In one case in the book, the cheating dealer made a mistake with her physical dexterity and accidentally made it plainly visible that she was dealing the second card from the top to Thorp. An agent supposed to police cheating casinos was present, but pretended not to notice.

Karl Pearson (1857–1936) discovered that the roulette numbers being reported daily in a French newspaper showed exploitable patterns. The mystery was resolved when it was discovered that rather than spend hours watching the wheels, the people recording the numbers simply made them up at the end of each day. The statistical patterns Pearson detected simply reflected the failure of the reporters to invent perfectly random numbers.

Some newspaper employees committed fraud too.

In fifty-five and a half years of marriage I don’t ever remember her [Thorp's wife, Vivian] bragging. The closest she came was when I would admire the way she matched the hues of her outfits or furnished our household with a designer’s eye. She would look at me and matter-of-factly explain, “I have a good eye for color.”

It's common that women believe they're good at that, but aren't. It takes skill, but people who have done nothing to develop any serious expertise often think they're good at it. Maybe Vivian is a rare exception (or read books and took classes, which Thorp didn't mention). But I doubt it. I think she's bragging because it's culturally acceptable for women to think they're good at this without seeming arrogant (and this cultural situation, not actual skill, is the key factor). Thorp himself seems to be pleased that his wife wasn't arrogant in general – and also be OK with her bragging about this (which he refuses to even say is bragging, he says it only came close to bragging).

the Math Department [at the University of California at Irvine] was headed for serious trouble. Both the levels of grant money for research and funds from the state of California to support the university had declined. This led to fierce struggles among various factions in the department for what was left. To mediate the infighting, an outsider was brought in as a chairman. He was forced out after three turbulent years. For want of anyone else who might be acceptable to the warring groups, and against my better judgment, I was persuaded by the administration to act as temporary chairman.

The assignment was worse than I thought. I found that one assistant professor had stopped showing up to teach, dividing his time between his girlfriend four hundred miles to the north in the San Francisco Bay Area and the casinos in Reno and Lake Tahoe. A card counter, he even called me with blackjack questions! Another assistant professor was running up departmental phone bills of $2,000 per month versus a total of $200 for the other twenty-five professors combined. When I confronted him he claimed it was mathematical research. A review of the bills showed almost all the charges were for calls to two numbers in New York City. I dialed each, speaking in turn to his mother and to a store that sold musical recordings. He was enraged at me and not at all embarrassed when exposed.

Meanwhile, a full professor had stolen the confidential employment records of another full professor from the department files. When I discovered this and confronted him, he refused to return it. It turned out that the file contained a very nasty letter that he had written about his enemy. He feared that if I, as chairman, learned what he had done, I would expose him. When I asked the administration to initiate disciplinary action against these incorrigibles, they declined to act. I was stunned and stymied.

One problem in large bureaucracies is that many of the members decide it is better not to cross people, instead of standing on principle. I asked a good friend, whom I had helped to get an appointment in our department, to become my vice chairman and help me. Although he was now a full professor with tenure, he declined, saying, “I have to live in the same cage with these monkeys.” I did understand his point. On the other hand, I was not confined to the cage. I had PNP [Thorp's hedge fund]. I thought, Why try to fix this if no one will even back me up? I was in the Math Department by choice, not by necessity. It was time to move on.

This is a good indication of how bad academia is.

To my astonishment, I found that XYZ Corp was offering to sell me options at less than half my expected payoff! After I collected financial statements from my friendly salesman and examined them, I discovered that when XYZ Corp sold an option it counted the proceeds as income, but did not set aside any reserve to pay off the options if and when they were cashed in by the buyer. Since the correct reserves on each option they sold should have been more than twice what they were being paid, proper accounting would show their net worth becoming more negative every time they sold another option.

It was clear that they had to sell more and more options, using the increasing cash flow to pay off any early “investors” who might cash in. Classic Ponzi, and bound to end badly. What to do?

I decided on a little educational experiment. After reviewing the scanty information available on sales, options outstanding, and early redemption rates, I estimated the company would survive for at least eight more months. It turned out to be ten. Buying $4,000 worth of six-month options, I doubled my money in four months and cashed out. A few months later the offices were shuttered, the operators gone, and another fraud investigation was under way.

This time, Thorp profited from a fraud.

I figured out a solution. I called our head trader, who as a minor general partner was highly compensated from his share of our fees, and gave him this order: Buy $5 million worth of index futures at whatever the current market price happened to be (about 190), and place orders to sell short at the market, with the index then trading at about 220, not $5 million worth of assorted stocks—which was the optimal amount to best hedge the futures—but $10 million. I chose twice as much stock as I wanted, guessing only about half would actually be shorted because of the scarcity of the required upticks, thus giving me the proper hedge. If substantially more or less stock was sold short, the hedge would not be as good but the 15 percent profit cushion gave us a wide band of protection against loss.

I went through a detailed explanation of my outside-the-box analysis of why this trade was a windfall opportunity. But this day was beyond anything our trader had ever seen or imagined. Gripped by fear, he seemed frozen. He refused to execute the trades. I told him to do it for PNP and do it now, or else I wanted him to do it for my account. If that was his choice, I told him I would later tell all the other partners how the profit I made would have, but for him, belonged to the partnership rather than to me.

Here was my reasoning. If, because of the uptick rule, only about half the shorts got off, then we would be properly hedged and make about $750,000. If none got off (extremely improbable), we were buying the futures at an enormous discount—the index itself would have to fall more than another 13 percent before we began to lose. At the other extreme, especially in a market panic, there was virtually no chance all the shorts would go off. Even if all the orders to sell short were completed, the market would have to rise more than 14 percent for us to lose money. To protect against this possibility, I told my head trader that when we filled close to half the short-sale orders, he should cancel the rest. After he finally complied with my request and completed the first round, I ordered a second round of the same size. In the end we did get roughly half our shorts off for a near-optimal hedge. We had about $9 million worth of futures long and $10 million worth of stock short, locking in $1 million profit. If my trader hadn’t wasted so much of the market day refusing to act, we could have done several more rounds and reaped additional millions.

Thorp's hedge fund lost millions of dollars because their stock trader didn't do his job. It's interesting to me how much dealing with people played a role here. Thorp couldn't just decide what to buy and sell, he had to persuade someone to do it (by threats, because explaining why it was profitable didn't work), even though the trader would not be affected by the outcomes of the trades and it was his job to make the trades Thorp chose.

I also found it interesting how little control Thorp had over what he bought. He ordered twice what he wanted figuring it wouldn't all happen. Why not just tell the trader to keep going until he gets to the amount Thorp actually wants?

See also my previous post on the book, School Mistreated Edward Thorp.

Elliot Temple | Permalink | Messages (0)