The following is part 1 of a special 4-part blog series.
What happens in Vegas, stays in Vegas. We’ve all heard this famous adage before and some of us even abide by it. One legend rejected this idea, however, and decided to expose what happened in Vegas.
This legend's name is Edward Thorp. Thorp is an American mathematics professor, author, hedge fund manager, and blackjack researcher. He received his Ph.D. in Mathematics at University of California, Los Angeles in 1958 and began his academic career at Massachusetts Institute of Technology in 1959.
Shortly before Thorp became a mathematics instructor at MIT, he and his wife took a trip to Las Vegas during Christmas break of 1958. Just before this trip, a friend gave Thorp an article on an analysis of the game of blackjack. Thorp hadn’t played blackjack before, but he wanted to try it out using the Baldwin Strategy, a strategy he’d recently come across in the Journal of the American Statistical Association.
When he got to Las Vegas, he bought 10 silver dollars and sat down at a blackjack table. At the end of half an hour, Thorp was down to $1.50, so he quit.
This experience preyed on Thorp's mind in the following months. Upon reviewing the article again, he realized the Baldwin system had a fatal flaw: It didn’t take into account that in blackjack (unlike most other games of chance) what happens in the hand before your hand, and the one before that, matters.
A successful system would need to factor in the odds of each and every scenario. Thorp knew these calculations would be way too big to solve by hand, but he was teaching at MIT at the time and thought MIT’s mainframe computer, an IBM 704, might be able to handle them.
Thorp taught himself the Fortran programming language and used it to program his theoretical research model and calculate the probabilities of winning at blackjack. He’d spend more than a year calculating probabilities, but the end result was a near-flawless way to count cards and a system that could potentially give players a 1% edge over the house.
Thorp was eager to publish his system. He thought that the most prestigious journal that might take the article was The Proceedings of the National Academy of Sciences. However, he needed a National Academy member to submit it. That’s where Claude Shannon came in. Claude Shannon was an American mathematician, electrical engineer, and cryptographer known as "the father of information theory."
In November 1960, Thorp met with Shannon to discuss his blackjack theory as well as his roulette prediction machine. Several hours later, Shannon agreed to submit the paper under one condition: the article’s title be changed from “A Winning Strategy for Blackjack” to “A Favorable Strategy for Twenty-one".
Just like that, Thorp’s ideas took off. You might be wondering "how are these geniuses related to financial markets"? Be on the lookout for the next few blog posts to put the pieces together!