Quote for the Week
Something which at first appears random or unpredictable may actually be predictable. Claude Shannon and I built a machine to beat roulette. Roulette normally appears to be a random process. But, sometimes, way back, players exploited defects in roulette wheels. Maybe one of the frets or dividers between the pockets is a little loose, so some pockets would be preferred over other pockets, so the numbers would come up with frequencies that deviated from random to some extent. The machine we built was even more advanced, it predicted position and velocity of ball and rotor, and from that we were able to forecast what region of the wheel the ball would fall into. We got a big edge. The machine is now in the MIT museum. So this is an example where, if you have more information about something that appears to be random, it could turn into an edge.
That’s also how markets are. The problem is that, even though markets aren’t strongly efficient in the sense of EMH, it’s still difficult to find edges. By “edge,” I mean excess return after adjusting for risk, net of costs. Also, when an edge is discovered, the money that’s poured into it makes the edge go away, because it moves prices toward correct pricing. So, I don’t think EMH is quite the right mental framework for thinking about markets, but it’s a good start for almost everybody. — Ed Thorp
From the Archives
Last Call
- Invest Like the Worst: Wealth-Destroying Portfolio Concentration – Owenomics
- Diversifying Equity Portfolios – Verdad
- Judas Goat – MicroCapClub
- “The Great Mirror of Folly”: 300 Years of Stock Market Manias – Periscope
- Is Your Overconfidence in Understanding Risk Leading You to Financial Ruin? – L. Swedroe
- Innovation, Domination, & Obsolescence – Andvari
- What is a Correlation, and How do You Think Clearly About It? – Clear Thinking
- Not Useless: We Just Don’t Know What It’s for Yet – Miller’s Book Review
- Perplexing the Web, One Probability Puzzle at a Time – Quanta
- The Long, Strange History of Teflon – Smithsonian