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10-K Diver

@10kdiver

Oct 12, 2021 • 11 tweets • 5 min read • Read on X

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@EdwardOThorp

1/

Ed Thorp (@EdwardOThorp) is a pioneer in the field of "how to recognize and take advantage of mis-priced bets".

This question has led Thorp to discover all kinds of fascinating and highly profitable strategies -- in Blackjack, Options Trading, Statistical Arbitrage, etc.

2/

In 2004 and 2005, Thorp published a 6-part article in Wilmott magazine.

In these parts, Thorp reminisced about his ventures into Statistical Arbitrage -- the science of profiting from the statistics of a large number of bets placed at once.

3/

I found this article to be an absolute gold mine.

It contains a wealth of investing/trading wisdom, plus a bunch of interesting nuggets from Thorp's extraordinary career.

👇👇👇

4/

Key insights/nuggets from Part 1:

- What does "market neutral" mean?
- How should we measure "risk-adjusted alpha"?
- Fundamentals of risk control via position sizing
- The importance of keeping transaction costs low

5/

Key insights/nuggets from Part 2:

- What is "arbitrage"?
- Types of arbitrage: riskless vs risky
- The fundamentals of Statistical Arbitrage
- Are markets efficient?

6/

Key insights/nuggets from Part 3:

- The importance of rigorous back-testing
- The fundamentals of Factor Analysis
- The founding of DE Shaw and Amazon

7/

Key insights/nuggets from Part 4:

- Why size tends to be an anchor of returns
- The fascinating story of Thorp buying an oil tanker

8/

Key insights/nuggets from Part 5:

- A precise definition of "haggling"
- Pros and cons of "haggling" while buying stocks
- Satisficers vs Maximizers: Good Enough vs The Best
- How Thorp got involved with Ken Griffin and Citadel

9/

Key insights/nuggets from Part 6:

- Fund manager fees, alignment of incentives
- The importance of running a lean organization
- The marginal value of "Time" vs "Money"

@WPoundstone

10/

If you want to learn more about Thorp, and about many other super-interesting characters who profited handsomely from asymmetric bets, I recommended the wonderful book "Fortune's Formula" by William Poundstone (@WPoundstone): amazon.com/Fortunes-Formu…

11/

Thanks for reading. I hope you enjoyed this thread!

/End

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More from @10kdiver

10-K Diver

@10kdiver

Jan 1, 2023

1/

Get a cup of coffee.

In this thread, I'll walk you through "Gambler's Ruin".

This is a classic exercise in probability theory.

But going beyond the math, this exercise can teach us a lot about life, business, and investing.

2/

In my mind, Gambler's Ruin is the math of "David vs Goliath" ("Skill vs Size") type situations.

Here, David is a "small" player. He only has limited resources. But he's very skilled.

Pitted against David is Goliath -- a "big" player who has MORE resources but LESS skill.

3/

The battle between David and Goliath rages on for several "rounds".

Each round has a "winner" -- either David or Goliath.

David -- because of his superior skill -- has a higher probability of winning any individual round. That's David's advantage over Goliath.

Read 32 tweets

10-K Diver

@10kdiver

Dec 11, 2022

1/

Get a cup of coffee.

In this thread, we'll explore the question:

As investors, how often should we check stock prices?

To answer this, we'll draw on key ideas and concepts from many different fields -- probability, information theory, psychology, etc.

2/

Imagine we have a stock: ABC, Inc.

Every day that the market is open, our stock either:

- Goes UP 1%, or
- Goes DOWN 1%.

For simplicity, let's say these are the only 2 possible outcomes on any given trading day.

3/

Suppose we think ABC is a "good" investment.

That is, the company has a wide moat, good returns on capital, decent growth prospects, etc. And the stock trades at a reasonable price.

So, we buy the stock -- expecting to make a very good return on it. Say, ~15% per year.

Read 40 tweets

10-K Diver

@10kdiver

Oct 23, 2022

1/

Get a cup of coffee.

In this thread, I'll walk you through 2 key portfolio diversification principles:

(i) Minimizing correlations, and
(ii) Re-balancing intelligently.

You don't need Markowitz's portfolio theory or the Kelly Criterion to understand these concepts.

2/

Imagine we have a stock: ABC Inc. Ticker: $ABC.

The good thing about ABC is: in 4 out of 5 years (ie, with probability 80%), the stock goes UP 30%.

But the *rest* of the time -- ie, with probability 20%, or in 1 out of 5 years -- the stock goes DOWN 50%.

3/

We have no way to predict in advance which years will be good and which will be bad.

So, let's say we just buy and hold ABC stock for a long time -- like 25 years.

The question is: what return are we most likely to get from ABC over these 25 years?

Read 23 tweets

10-K Diver

@10kdiver

Sep 11, 2022

1/

Get a cup of coffee.

In this thread, I'll walk you through the P/E Ratio.

Why do some companies trade at 5x earnings and others trade at 50x earnings?

When I first started investing, this was hard for me to understand.

So, let me break it down for you.

2/

Imagine we have 2 companies, A and B.

Let's say both companies will earn $1 per share next year.

And both companies will also GROW their earnings at the SAME rate: 10% per year. Every year. Forever.

3/

Suppose A trades at a (forward) P/E Ratio of 10. So, each share of A costs $10.

And B trades at a P/E Ratio of 15. So, each share of B costs $15.

Which is the better long term investment: A or B?

Read 31 tweets

10-K Diver

@10kdiver

Sep 4, 2022

1/

Get a cup of coffee.

In this thread, I'll walk you through a fundamental business concept that may be counter-intuitive to some of you:

Just because a business has made $1 of PROFIT, it does NOT mean the business's owners have $1 of CASH to pocket.

2/

To understand why, let's start with how PROFIT is defined.

PROFIT = SALES - COSTS

That is, we take all sales (or revenues) the company made during a quarter or year.

We back out all costs incurred during this period.

That leaves us with profits.

Seems straightforward.

3/

Here's the problem:

The way a "lay person" understands words like SALES and COSTS is completely different from the way an *accountant* uses these same words.

These discrepancies can create enormous confusion.

Read 20 tweets

10-K Diver

@10kdiver

Aug 28, 2022

1/

Get a cup of coffee.

In this thread, I'll walk you through a framework that I call "Lindy vs Turkey".

This is a super-useful set of ideas for investors.

Time and again, these ideas have helped me think more clearly about the LONGEVITY of the companies in my portfolio.

2/

Imagine we're buying shares in a company -- ABC Inc.

ABC is a very simple company. It earns $1 per share every year. These earnings don't grow over time.

And ABC returns all its earnings back to its owners -- by issuing a $1/share dividend at the end of each year.

3/

Suppose we buy ABC shares for $5 a share.

That's a P/E ratio of 5.

We know we get back $1/year as a dividend.

So, for us to NOT lose money, ABC should survive AT LEAST 5 more years.

If something happens and ABC DIES before then, we'll likely lose money.

Read 32 tweets

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