Review of Fortune's Formula

Title:

Fortune's Formula

Author:

William Poundstone

Publisher:

Hill and Wang

Date:

2005

ISBN:

0-8090-4637-7

Pages:

386

Price:

$27.00

Reviewed by Nick Christenson, npc@lvrevealed.com

November 8, 2005

Advantage gambling, personal finance, and the science of information theory have a greater overlap than many people might at first think. Problems in gambling and finance can be posed in the language of information theory, and when one applies the techniques of this obscure branch of mathematics to problems in the financial realm, remarkable solutions present themselves. This overlap is the subject of William Poundstone's latest book, Fortune's Formula.

At the dawn of the computer age, scientists were grappling with a mathematical way to represent information transmission and storage. One of the pioneers of this new science was a true genius named Claude Shannon. Fortune's Formula spends quite a bit of time providing insight and background into this fascinating character. Surprisingly little is known about Shannon, but Poundstone has done exhaustive research into the life of this private person.

One of the results that came out of information theory is called the Kelly Criterion, named for John Kelly, the man who published this remarkable finding. The Kelly Criterion will be familiar to well-read gamblers as the principle that one should wager a percentage of one's bankroll equal to the advantage of that particular bet. Despite being mathematically proven, this is a controversial assertion that has wide-ranging implications, not just for gambling, but for finance as well.

Fortune's Formula explores the implications of this result and the debate that surrounds it, ranging from Ed Thorpe card counting at blackjack to the fall of the Long Term Capital Management hedge fund. I consider myself fairly well versed with information theory and the gambling literature, and I'm more than a little familiar with contemporary finance, but I was absolutely astounded by the number and depth of the connections between these different realms. Poundstone does an amazing job of linking these worlds, and I can't imagine that anyone with an interest in these topics will fail to be blown away by this web of connections.

Those who have followed my reviews will not be surprised that I would have preferred the book to be more technical in its exploration of its topics. However, while Poundstone's story is easily accessible to those without a strong background in mathematics or finance, I still found its depth to be fulfilling. The author skillfully walks a fine line by providing enough detail so that the technically astute reader can get a few glimpses "under the hood", but without losing his more casual audience.

On balance, Poundstone is "pro-Kelly", and those who have read other reviews of mine will probably correctly guess that I am as well. The "finance establishment" and others have been surprisingly (to me) hostile to direct application of the Kelly Criterion to investing. Even though the book does present both sides of the story, it's clear that the book does take a stand. I think that the author could have made a stronger case by doing more to address some of the reasonable concerns that the "anti-Kelly" folks have about the application of the theory. This should be taken as a minor complaint, however. I believe that Poundstone's treatment is fair, just not as rigorous as it could be.

Fortune's Formula is a fascinating story, and I would expect that anyone with an interest in gambling, applied mathematics, or finance ought to read this book. It will contain new information, perspectives, and associations, even for those who know a great deal of this remarkable scientific principle and the amazing people who are associated with it. Reading this book won't make one a better gambler or information theorist, although it might make one a better investor. However, it is interesting, entertaining, and informative, and I recommend it.

Capsule:

Fortune's Formula is the story of the principle from information theory known as the Kelly Criterion and it's applications in gambling and especially finance. This is an interesting, informative, and, I believe, fair treatment of an important, but often overlooked mathematical truth. This is much more the story about this principle than it is an exegesis on how to apply it, but even so, I'd expect a great many people might learn much that is worthwhile from what it has to say. I found it interesting, and I recommend it.