59a7edb9cd894A_man_for_all_markets_pictuIn “A man for all markets”,  Edward Thorp tells his incredible life story. The book is filled with practical wisdom on investments and life in general. Here I will concentrate briefly on those parts that might be of interest to the Stockopedia community.

Interestingly, this is also the only book Charlie Munger recommended at the 2017 meeting of the Daily Journal Corporation.

Dr Thorp, born in 1932, was an American mathematics professor, who became an extremely successful quantitative hedge fund manager. He started investing in financial markets using his winnings from a money-making foray into gambling which he describes in his book “Beat the Dealer”. Dr Thorp is the first person to derive and then apply theoretically sound option pricing models to financial markets.

His Principal Newport Partners hedge fund outperformed the S&P500, on a gross basis, by about 9% per annum from 1969 to 1988, without one negative year. His XYZ statistical arbitrage fund outperformed the S&P500 by 10.4% per annum for the ten year period 1992 to 2002, on an un-levered basis.

Dr Thorp was not interested in the fundamental worth of businesses, but rather in using his mathematical skill in finding relative mispricing among securities. He did, however, make a very profitable investment in Berkshire Hathaway, after he played bridge with Warren Buffett. He recounts that meeting Mr Buffett also helped him to move along the path to his own hedge fund.
Dr Thorp probably started the first ever quantitative market neutral hedge fund. The hedging of mispriced securities with optionality was a major source of profit. This included stock options, warrants, convertible bonds and convertible preference shares.

Probably of more interest to Stockopedia subscribers is his use of statistical arbitrage. His trading systems were based on a combination of indicators, similar to those used in many of the Stockopedia screens. He mentions the use of earnings yields, dividend yields, price-to-book ratios, momentum, short interest, earnings surprises and trading by company insiders. The profitability of his systems was, however, dependent on market conditions.

He also developed a successful trading system, which he called “most-up-most-down”. This involved buying the stocks that had fallen the most (the bottom 10%) and selling short those that rose the most (the top 10%) during the previous two weeks.

He examined “charting” or the technical analysis of stocks and…

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