The Book - Beat The Dealer and Money Management

A couple of weeks ago I read the weekend edition of the Wall Street Journal and there was a great interview / article with Bill Gross and Edward Thorp. Bill Gross is the billionaire bond manager who controls the bond firm PIMCO on the West coast. Edward Thorp is the author of the book 'Beat The Dealer.' Edward Thorp was an MIT professor and wrote 'Beat the Dealer' after studying Black Jack and writing a paper about it. The book was written in the 1960s and it explains in elaborate detail how to win at the game of Black Jack. Bill Gross came across the book and studied the method then went to Vegas and applied it and won. What I found interesting is that Bill Gross who now manages about $1 trillion in assets uses some of the techniques to manage money at PIMCO. The big rule that he uses is the one about money management.

In the book Thorp teaches that unless your edge is strong to 'play' a small hand but that once the odds increase in your favor to then increase the bet size. I have read over and over again in many trading books about money management and that sizing the bet is one of the most important factors to longevity and success in the money management business. I personally believe that it is the most important factor. The reason is that if one makes bets that are consistently too large without having a consistent edge in all of those positions then the chances are very high that the trader is going to blow up. This was LTCM's problem in 1998 when they 'blew up'. No matter how strong their edge was it was not strong enough to outlast the negative forces that overtook their portfolio. Their bets were simply too large and they ran out of money before the positions came back to their favor. This was the SocGen problem with that trader Kerviel as well - position size.

Learn to size trades and you may be successful in this brutal business. Thanks to the Wall Street Journal for writing that great article and to Edward Thorp for writing that amazing book and to Bill Gross for explaining again the importance of money management. If you want an entertaining book and want to show off to your friends when you go to a casino, read Thorp's book 'Beat The Dealer'. It cost me $12. Definitely up there with some of the best $12 I have ever spent.