Hedge Fund Market Wizards

Chapter 6

Edward Thorp

The Innovator

Can the markets be beat? Not unless you are lucky, according to proponents of the efficient market hypothesis (EMH), which assumes that the markets discount all known information and immediately reflect all new information. What about traders who have achieved exceptional track records including some of those profiled in this book? EMH believers have a ready response, which is a variant of the popular Shakespearean monkey argument—that is, if you have enough monkeys randomly striking keyboard keys (they have recently traded in their typewriters for PCs), one of them will eventually type Hamlet. By analogy, the implication is that if you have enough traders, some of them will do exceptionally well simply by chance. While the Shakespearean monkey argument is perfectly valid, the question that is always left unaddressed is: How many monkeys would you need to get a randomly generated copy of Hamlet? Answer: A lot of monkeys. Unimaginably more monkeys than could be squeezed into the visible universe. The relevant question then is: If trading results are based on chance, how many traders would you need to get one or more with a track record as good as one of the best actually achieved? (If EMH is correct, then all trading results are a matter of chance.) Thorp’s track record provides a useful proxy to answer this question.

Thorp’s original fund, Princeton Newport Partners, ran for 19 years (November 1969 to December 1988) and had an average annualized ...