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REAL TALK ON
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Gambling and Gaming
Wall Street Casino

Gambling and Gaming
Wall Street Casino

Garrett Baldwin



[Editor's note: This is part four of a five-part series of stories on the intersection between gaming and trading. In this piece, Modern Trader sits down and discusses Blackjack and the markets with Blackjack Hall-of-Famer and Hedge Fund guru Edward O. Thorp. To return to Part 1, visit here]

In April 2010, New York Times reporter Andrew Ross Sorkin tabbed a column that highlighted the similarities between the casino mentality of some Wall Street banks and traditional sports gamblers leading up to the financial crisis.

“One side bets the value will rise, and the other side bets it will fall. It is no different than betting on the New York Yankees vs. the Oakland Athletics, except that if a sports bet goes bad, American taxpayers don’t pay the bookie,” he wrote. 

The comparison is touchy on Wall Street, Capitol Hill and in trading pits. 

That’s why it seemed important to seek the insight of hedge fund manager, mathematics professor, probability theorist, Blackjack Hall of Fame member and best-selling author Edward O. Thorp. 

Thorp’s career has traveled the fine line between Wall Street investment and gambling for decades. 

Author of the 1962 classic book, “Beat the Dealer: A Winning Strategy for the Game of Twenty-One,” Thorp devised a strategy that could mathematically reduce a casino’s house advantage through card counting (see “Beating the house,” below). More than 50 years later, blackjack remains one of the most popular table games worldwide thanks to his groundbreaking research. 

Thorp also applied his mathematical prowess as the head of hedge fund Princeton/Newport Partners. Today, he is the President of Edward O. Thorp & Associates, a firm based in Newport Beach, California.

With a focus on the theory and the mathematics, Thorp sees just a few differences between gambling and investing.

“Gambling is investing simplified,” he says. “You consider a choice of bets with payoffs, and calculate a set of probabilities. Using probability theory, we can determine a range of outcomes. Investing is the same thing. We can buy stocks and hold them for a period with a probability of payoffs. The biggest difference is that the casino has an edge, while the individual is more likely to lose,” says Thorp. “On the securities side, investors tend to make money as societies progress.”

That key distinction is important, and returns the conversation back to what Sorkin wrote in 2010. First, many traditional investors and traders place their money in the markets to obtain a long-term return. Buyers and sellers have competing views on companies and economies, but no one holds a consistent edge. 

However, when one group has knowledge of a trade when the broader market does not (as Goldman Sachs was accused of misleading clients, selling bundled bad debt and betting on the housing crisis), how can this be considered investing? 

As Thorp notes, bad actors exist in both the gambling sector and on Wall Street. They always have.

Technology blurs the lines more than ever

One concern that emerges is that more advanced technology can provide some with an edge over the vast majority of both traders and gamblers. 

Thorp raises concerns about the impact of technology on gaming, particularly the shift to player-vs.-machine games that now include games like poker and blackjack, which used to center on human interaction. 

“Technology makes betting less personal and more detached for the casinos. In many ways, the gambling experience is dehumanized,” Thorp says. “If you walk into a casino, people are staring at blinking lights. It’s almost like science fiction.”

But the dehumanization process isn’t the sole issue raised by Thorp. A technological concern intersects the gambling and the investing worlds: A matter of transparency.

“As technology dehumanizes gambling, it makes it more difficult to know about the house’s edges and whether they are being honest,” he says. “How do you know that the odds and the payouts are correct? How do you know if someone hasn’t fixed a machine that takes a little more off the top? More important, who is going to catch them? And if someone did something wrong, to whom do they pay it back?”

Technology’s role in trading is also a contentious point of debate given today’s massive proliferation of high-frequency traders. “High-frequency traders have a statistical advantage. This is clear when you have a situation when they are able to pump money out of the markets and have cases where a firm has almost 1,300 winning days in a row.” Thorp is referencing HFT firm Virtu Financial, which had one losing day of trades in a five-year span. The company planned to go public in 2014, but reversed course after a bout of volatility and negative sentiment following the publishing of Michael Lewis’ book “Flash Boys.” Thorp says, “You know that they have a privileged position.” 

The world's biggest casino

This doesn’t suggest that technology isn’t an important and valued tool in the stock markets or in gambling. The proliferation of technological systems has made the markets more liquid, moved traders out of ticker-taped pits and provided a multitude of platforms on which they can gather and crunch information. 

Technology certainly can be used to favor the gambler as well. Technology allowed Thorp to advance his theories on blackjack and ultimately apply his knowledge to the financial markets.

Thorp’s mathematical prowess propelled him to study blackjack in 1958 after he stumbled across an article on strategy that was written by four members of the U.S. military. Using a self-programmed IBM computer, Thorp devised the first card-counting strategy. Though many gamblers first dismissed his theories, he worked with Las Vegas bookie Emmanuel Kimmel to test his card-counting system. 
It produced immediate results. 

Following the publication of “Beat the Dealer,” two things happened. First, blackjack moved into the mainstream as a favorite game in casinos. Second, casinos colluded in 1964 and changed the rules. They would reverse this decision after players abandoned the game, but not before they introduced additional decks and a dealer shoe, which enabled more frequent shuffling. 

A few years later, Thorp moved to Wall Street, where he felt right at home with his statistical background. Thorp’s website boasts that his hedge funds and his personal portfolio were profitable in 42 of the subsequent 43 years since making the leap. With the growth of both Wall Street and the gambling sectors, he sees many similarities.

“Wall Street is the world’s largest casino,” he says.

Plus, he’s also seen enough to know that the theories remain the same, but the terminology can change. A common topic of discussion has centered on how individuals define the term “gambling.” During the last decade, casinos have taken the “B” and the “L” out of gambling and promoted their hotels and resorts as hubs for “gaming.”

Thorp simply laughs. “Casinos call it gaming because ‘gambling’ has negative connotations. That’s like a janitor reclassifying himself as ‘custodial engineer.’”

 

Go to Part Five: Why Wall Street Hires Poker Pros

 

About Garrett Baldwin

Camden 2  medium

Garrett Baldwin is the Managing Editor of the Alpha Pages and the Features Editor of Modern Trader. He has covered the financial markets since the onset of the RBS collapse in 2007. An author and Baltimore native, he earned a BS in journalism from the Medill School at Northwestern University. He holds an MA in Economic Policy (Security Studies) from The Johns Hopkins University, an MS in Agricultural Economics from Purdue University and will finish an MBA in finance from Indiana University in 2015.

Twitter: @garrettbaldwin, @alphaeditors, @TheAlphaPages

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