I happened across this gem of a book one day while browsing in my local mega-bookstore. The jacket of "Fortune's Formula" has a couple of casino chips on the front, which at a glance makes it look like a about poker. That probably makes good marketing sense these days, but it would be a shame if this gem of a book got lost among all those vainglorious Texas Hold'Em books and pounds of latin square pornography.
Poundstone's book is an engaging tale of mafiosi and mathematicians. Organized as a series of connected vignettes of colorful characters, Poundstone provides decent biographies of mathematicians such as Claude Shannon (the father of information theory), Edward Thorpe (the inventor of blackjack card counting), and John Kelly. While Kelly died young, his legacy is the namesake of the book: through a clever application of information theory, Kelly derived a money management scheme that has intrigued gamblers ever since. His paper is a clear and well-written piece of applied mathematics that is well worth reading on its own, although Poundstone gives a very good (and surprisingly detailed) discussion of the paper.
Kelly provides an approach to managing your money in gambling games that avoids gambler's ruin. Roughly, Kelly's scheme works as follows: invest a proportion of your capital on each bet in a way that balances the odds of winning versus your edge over the game.
Kelly's work piqued the interest of Claude Shannon who, in collaboration with colleague Edward Thorpe, developed a machine to beat roulette. Thorpe later became famous for blackjack card counting, with his initial "field work" funded by the mafia (unbeknownst to a naïve Thorpe).
After their foray into Vegas table games, both Shannon and Thorpe turned their attention to the stock market. Thorpe eventually went to work full-time for a highly successful Wall Street hedge fund, applying Kelly's ideas to some of the earliest computer models for stock trading. Indeed, Thorpe claims (with no hint of envy) that his model was essentially the same as the famous Black-Scholes pricing equations for which Merton and Scholes shared the 1997 Nobel Prize in Economics. Poundstone's account of the rise and fall of Thorpe's company is a fascinating one, involving personalities such as Michael Milkin and Rudy Giuliani.
Shannon's interest in the stock market never took him to Wall Street full time, but his investing success makes Thales' purchase of all those olive presses look like small potatoes. Poundstone pieces together the evidence, noting that when asked if it's possible to beat the market, Shannon said yes, through arbitrage. Shannon also gave a lecture in the 1970s that showed how, at least in theory, one could make money on the random fluctuations in the stock market index. Poundstone engagingly pieces the evidence together and comes to a somewhat surprising conclusion about the secret to Shannon's success.
Economist Paul Samuelson, and other members of the "random walk cosa nostra", make an appearance in the book. Samuelson's pugnaciousness in defending his point of view is great fun; he even wrote an essay consisting of single syllable words, mocking the faith that "Kelly bettors" have in their system. As a quick googling will attest, many sports bettors have a major like or dislike for the Kelly the system. Indeed, with its requirement for knowing your edge over the game, Kelly's system has sometimes raised eyebrows as being a system that needs insider information to work in practice.
Perhaps the only critique of this entertaining book is that covers too many stories, and goes off on too many tangents. I wouldn't have minded if, for instance, Poundstone had delved more deeply into the most interesting characters, such as Shannon and Thorpe.
Another problem with this book, which is really only a problem if you are expecting Poundstone to let you in on a get-rich quick scheme, is that Shannon and Thorpe's investing secrets involves a heck of a lot of hard work, persistence, and a least a little bit of luck. As they say in those poker books, fortune's formula promises a hard way to make an easy living.
Toby Donaldson is an instructor in Simon Fraser University's School of Computing Science.