Three Financial & Technological Contributions from the Father of Card Counting

Today, most people know the term ‘card counting’ as some sort of casino legend. Most wrongfully assume card counting is illegal, limited to savant geniuses, or that it simply can’t happen with modern security. In reality, card counting in blackjack is legal—though most casinos retain the right to remove suspected card counters from their grounds.

Over the years, Hollywood has incorporated card counting into high-stakes dramas, from Rain Man to 21. Only a few have been (loosely) based on the real-life gig, such as Kevin Spacey’s demanding leader of an MIT card counting group in 21.

Few projects have been able to accurately depict both the nuance and statistical knowledge needed to pull off card counting—especially now that most casinos use multiple decks (or ‘shoes’) to prevent potential counters. In fact, it’s likely a dying art.

First, casinos are smart to most modern card counting operations. Advances in security measures have made card counters less successful than ever. Second, many gamers have moved to virtual tables for access to online US casino bonuses, the convenience of playing remotely, and less social pressure from other players.

This doesn’t mean card counting has disappeared or will anytime soon. Instead, it hints that the existing teams are more invisible than ever, and have likely devised strategies for staying under the radar. As shown by Edward Thorp, the father of card counting, discretion pays.

For the Love of Stats

In reality, MIT was actually involved in blackjack card counting, as shown in the film 21. Back in 1958, a man named Edward Thorp graduated from UCLA with a doctorate in mathematics. He then headed to MIT, where he worked as a professor of mathematics before moving to New Mexico State University in 1961.

During his time at MIT and New Mexico University, Thorp translated his knowledge of probability into a strategy for beating the house at blackjack. He did this by applying probability theories that he’d studied in school toward blackjack. Using mathematics and statistics, Thorp proved that it was possible to beat the house.

He published his findings in Beat the Dealer in 1962. The book is hailed as the seminal work that subsequent card counters would rely on. One gamer in the 70s, Al Francesco, used Beat the Dealer strategies to form an elite card-counting team. Soon after, one of his team members, Ken Uston (a graduate of MIT), published a tell-all book about card counting strategy and teams, titled Million Dollar Blackjack in 1982.

Men like Francesco and Uston helped turn card counting into a flashy, Hollywood-worthy topic. However, Thorp never deviated from his emphasis on probability theory. In fact, he translated his findings in blackjack to the stock market with great success.

For gamers, Edward Thorp is the father of card counting. But for economists and financial strategists, Thorp is known as the father of quant investing. Here are three of his greatest contributions beyond the realm of blackjack.

One: The Quant Fund

Half a century before machine learning algorithms started handling data to solve problems, Thorp knew the value of numerical data. He used economic data to create quantitative analysis on investment funds to determine their security and make solid investments.

Today, economists use customized software programs to determine these predictions. Back in the day, Thorp used his knowledge of probability and statistics to make these determinations. This helped him make huge amounts in the securities market, as well as launch the very first quant hedge fund.

His understanding of the market from a statistical perspective helped Thorp reveal Bernie Madoff as a scammer a full decade before others were any the wiser. But his early work has had other, greater effects. It highlighted one of the earliest applications of big data, which are now used by financial professionals to gain perspective on markets.

Two: A Wearable Computer to Tackle Roulette

Though Thorp spent most of his career working in the stock market, he returned to the casino to tackle roulette from a probability standpoint. His desire to create a system for beating the house in roulette led him to create the first wearable computer with fellow mathematician Claude Shannon.

Shortly after publishing Beat the Dealer, Thorp and Shannon created a system to gauge how fast the roulette wheel was spun and, thus, where the ball was likely to land. To do this, two players would be present at the roulette table. One would input the cadence of the spun wheel, while the other would hear this message through an earpiece.

The device was later made illegal, but not before Thorp and Shannon learned how to gain a 44% edge on the house. Their work in roulette wouldn’t last quite as long but, similar to quant hedge funds, Thorp’s early work with wearable technology would prove to be a hit in the decades to come.

Three: Market Neutral Derivatives Hedging

Though quant funds have become a standard part of financial technology in the stock market, Thorp made meaningful contributions to market-neutral funds, too. Market-neutral funds look to create small profits regardless of how the market is moving.

This idea is deceptively complex. In order to maintain year-over-year profit, professionals need to implement strategies that are often highly leveraged, which can generate risk. In other words, it’s not quite as stable as the standard mutual fund, leading many to regard them as high-risk.

In the coming years, indexes like the S&P 500 would become a benchmark for many in the industry. However, Thorp was able to achieve profitability by creating an options pricing formula long before the S&P 500 model emerged. His first hedge fund, Princeton Newport Partners, compounded at 19.1%, much greater than the prevailing S&P standard.

This also led Thorp to Ken Griffin’s Citadel, which is one of the most influential and successful hedge funds ever created, where he served as the first limited partner. Thorp inspired other big players in the stock markets, including the manager of one of the world’s largest mutual funds, Bill Gross, who went on to become known as the ‘bond king’.

This article does not necessarily reflect the opinions of the editors or the management of EconoTimes