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The Little Book of Market Wizards: Lessons from the Greatest Traders by Jack D. Schwager

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Chapter Fifteen

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Size Matters

The Power of Bet Size

Edward Thorp’s track record must certainly stand as one of the best of all time. His original fund, Princeton Newport Partners, achieved an annualized gross return of 19.1 percent (15.1 percent after fees) over a 19-year period. Even more impressive was the extraordinary consistency of return: 227 out of a total of 230 were winning months and a worst monthly loss under 1 percent. A second fund, Ridgeline Partners, averaged 21 percent annually over a 10-year period with only a 7 percent annualized volatility.

Before he ever became interested in markets, Edward Thorp was a math professor whose avocation was devising methods to win at various casino games—an endeavor widely assumed to be impossible. After all, how could anyone possibly devise a winning strategy for games in which the player had a negative edge? One might think that a math professor would be the last person to devote time to such a seemingly futile goal. Thorp, however, approached the problem in a completely unconventional manner. For example, in roulette, Thorpe, along with Claude Shannon (known as “the father of information theory”), created a miniature computer that used Newtonian physics to predict the octant of the wheel in which the ball was most likely to land.

By analogy to blackjack, trading larger for higher-probability trades and smaller, or not at all, ...

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