A Rule For Gaining Advantage In Life and Investing

Anything everyone knows is not worth knowing

Oh no! What about our sacred beliefs. They are all good I am sure, but they provide no tradeable advantage. You can’t get ahead without an advantage.

Ed Thorpe

Edward O. Thorpe is a mathematician, a professor, a blackjack player and a hedge fund manager. A peculiar career path, but explainable when you realize his mathematical training is in statistics.

Most of life is about probabilities, tendencies and luck. Statisticians are good at assessing those.

The book, “Beat the Dealer”

In 1966, Thorpe published the ideas he had found in the play of blackjack. If one counted the cards that had been played, one knew the probability of the next card being suitable for the hand in play. A small but consistent edge can make you a lot of money. Money the casinos used to keep.

The casinos eventually refused to let him play at all. Disguises helped for a while. Moving around to different cities helped too. Eventually the casinos used systemic defenses. They shuffled the deck well before all the cards had been played. They then began to use multiple decks. It is very difficult to gain an advantage when the deck is actually 8 decks and it is replaced when half the cards have been played.

All advantages disappear by implementing countervailing methods.

Thorpe went on to the stock market.

A far larger market than casino blackjack. He of course discovered pricing anomalies there too. He was rewarded with a considerable fortune from taking advantage of the inefficiencies in the market. His self-reported return was 20% annually for three decades.

It is possible that the market is not as efficient as they would have you believe. Not to say you can do much about that.

Inefficiencies disappear

Just as with the casinos, the market adapts to anomolies by pricing them out of existence. In the 60s and 70s it was possible to run an inter-market hedge fund that took advantage of price variations between markets. Today, high velocity trading eliminates those in microseconds. Relative pricing inefficiencies has also nearly disappeared. Again computers and algorithmic trading has reduced the opportunity. Sometimes options are mispriced and again the mispricing is promptly repaired.

If a company believes their stock to be dramatically undervalued, they can buy it back or take it private. People react to pricing errors.

Long Term Capital Management disappeared in the chaos of believing relative pricing of securities always made sense.

There are lessons here.

  1. No large discrepancies in pricing exist for long in the stock market.
  2. People adapt and change the rules, like the casinos, or they generate ways to take advantage of the anomalies. Like the high velocity traders.
  3. If you trade on pricing errors, you can make money as long as you are the only one who has noticed that particular error.
  4. Some investors refuse to play the game. You do not have to invest based on market pricing. Most of today’s super-investors invest in businesses. They use an entirely different method of deciding value and merely wait for the stock market to deliver up attractive pricing. Pricing that may contain no mistakes in a market sense, but which are at odds with the business value.

Remember the rule.

Anything everyone knows is not worth knowing.

A university education gives you an earning advantage until everyone has one.

Index funds always beat managed funds. Think about it. I wonder who is already adapting to that belief?

Don Shaughnessy arranges life insurance for people who understand the value of a life insured estate. He can be reached at The Protectors Group, a large insurance, employee benefits, and investment agency in Peterborough, Ontario. 

In previous careers, he has been a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business.

Please be in touch if I can help you. don@moneyfyi.com  866-285-7772


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