Fortune’s Formula: The Science Behind Beating Casinos and Wall Street and How it Relates to Asymmetric Trading

William Poundstone’s Fortune’s Formula tells the untold story of how a mathematical betting system—the Kelly Criterion—was used to beat both casinos and financial markets. The book weaves together mathematics, probability theory, game theory, and financial history, exploring how key figures like Claude Shannon, John Kelly Jr., and Edward Thorp used scientific methods to gain an asymmetric edge in gambling and investing.

This book isn’t just about blackjack and horse racing—it’s about how information theory, arbitrage, and risk management create asymmetric opportunities in financial markets. It delves into market inefficiencies, arbitrage strategies, and the dangers of leverage, all while tying these lessons to modern investing.

Part 1: The Birth of a Betting System (Entropy & Claude Shannon)

The story begins with Claude Shannon, the father of information theory, who worked at Bell Labs. Shannon’s work on entropy and signal processing laid the foundation for understanding randomness and uncertainty. His discoveries influenced everything from computing to gambling strategies.

Shannon realized that randomness could be quantified, a principle that later helped decode financial markets.
His ideas led to communication systems, early AI, and even market inefficiency theories.
Shannon’s research set the stage for John Kelly Jr., a Bell Labs scientist who created the Kelly Criterion—a system that optimizes bet sizing for long-term capital growth.

The Kelly Criterion: A Mathematician’s Guide to Betting & Investing

John Kelly Jr. formalized a mathematical rule for betting, now known as the Kelly Criterion, which determines the optimal fraction of capital to wager based on probability.

The formula:

Key takeaways:

The Kelly system maximizes long-term compounding, ensuring that bets (or trades) grow capital exponentially while limiting ruin.
Unlike fixed-percentage betting or all-in bets, the Kelly Criterion scales risk appropriately based on the odds, making it a cornerstone of asymmetric investing.
The Kelly approach later found a home on Wall Street, where it became part of quantitative trading strategies.

Part 2: Beating Blackjack & the Rise of Edward Thorp

Edward Thorp’s Card Counting Revolution

One of the first practical applications of the Kelly Criterion came from Edward Thorp, a mathematician who applied probability theory to blackjack.

Thorp developed a card-counting system, proving that blackjack is not a game of pure chance—it can be beaten systematically.
His MIT-backed research led to the first-ever scientifically proven gambling strategy, outlined in his 1962 book Beat the Dealer.
Thorp’s card counting strategy forced casinos to change rules, proving that mathematics could provide an edge.

Thorp later applied these principles to investing, pioneering quantitative hedge fund strategies that reshaped financial markets.

Why this matters for asymmetric investing:

Thorp limited downside and maximized upside, the core principle of asymmetry.
His blackjack strategy mirrors asymmetric trade structuring, where precise risk-taking creates long-term advantages.

Part 3: Arbitrage, Market Inefficiencies & Beating Wall Street

The book transitions from casinos to financial markets, focusing on arbitrage strategies, probability-based trading, and the flaws in efficient market theory.

The Random Walk vs. Market Inefficiencies

Traditional finance theories, like the Random Walk Hypothesis, suggest that markets are efficient.
Poundstone challenges this, arguing that traders like Thorp, Shannon, and Renaissance Technologies have consistently beaten the market by finding hidden inefficiencies.
The Kelly Criterion was adapted to options trading, arbitrage strategies, and market anomalies, giving quants an edge.

Michael Milken & Junk Bonds

The book explores how junk bonds and leveraged buyouts used principles of asymmetric risk/reward, much like Kelly’s system.
Milken exploited market inefficiencies, showing how high-yield bonds could provide massive upside with controlled downside.

Robert C. Merton & Quantitative Finance

The rise of quantitative models, including Black-Scholes and Kelly-based strategies, proved that risk could be priced and managed scientifically.
The flaws in these models, however, led to blow-ups like Long-Term Capital Management (LTCM) when risk was mispriced and leveraged excessively.

Part 4: The Dark Side – Market Manipulation & The Danger of Leverage

The Dangers of Overleveraging (Blowing Up)

Poundstone warns against the excessive use of leverage, which can turn an asymmetric opportunity into a disaster.
The book covers traders who ignored risk management and suffered catastrophic losses, reinforcing the importance of capital preservation.
The Kelly Criterion must be used conservatively—overestimating your edge can lead to blow-ups.

The Wire Service & Market Manipulation

The book explores historical market manipulation—from horse racing bookies using insider info to hedge funds exploiting financial loopholes.
Information asymmetry remains a major driver of market profits—those with an edge in information processing win.

Part 5: Key Lessons for Asymmetric Investing

1. Position Sizing is Everything

The Kelly Criterion offers a mathematical framework for optimal position sizing.
Asymmetric investing relies on proper risk sizing—too little risk leads to underperformance, too much leads to ruin.

2. Markets Aren’t Fully Efficient

Systematic traders & arbitrageurs have consistently beaten markets, proving that information asymmetry exists.
The Kelly Criterion thrives in inefficient markets where edges can be exploited.

3. Leverage is a Double-Edged Sword

The Kelly formula is optimal but must be adjusted for real-world risk.
Too much leverage leads to blow-ups, as seen in LTCM and hedge fund collapses.

4. Asymmetry Requires Discipline

Applying probability-based strategies consistently is key to long-term compounding.
Portfolio heat management ensures that multiple asymmetric trades don’t create excessive exposure.

Fortune’s Formula & Asymmetric Trading

Fortune’s Formula is more than a gambling book—it’s a blueprint for asymmetric investing. It highlights how probability, information theory, and disciplined risk management create repeatable edges in markets.

The Kelly Criterion’s core principle—maximizing growth while capping downside—perfectly aligns with asymmetric investing. By structuring trades with limited risk and unlimited upside, investors can compound capital efficiently.