Ed Thorp: The Importance Of Having An Edge In Investing

Johnny HopkinsEd ThorpLeave a Comment

Here’s some great investing insights from Ed Thorp, author of Beat the Dealer and A Man for All Markets, from his interview with Jack Schwager in his book – Hedge Fund Market Wizards. During the interview, Thorp explained the importance of having an edge in investing and matching your skill set with your investing strategy. Here’s an excerpt from that interview:

What are your thoughts on the efficient market hypothesis?

Based on our daily success in Princeton Newport Partners, the question wasn’t “Is the market efficient?” but rather the appropriate questions were “How inefficient is the market?” and “How can we exploit the inefficiencies?”. The claim of market efficiency, which implies that no market edge is possible, is a hollow statement because you can’t prove a negative. But you can disprove market efficiency if there are people who have a demonstrable edge. There is a market inefficiency if there is a participant who can generate excess risk-adjusted returns that can be logically explained in a way that is difficult to rebut. Convertible arbitrage is a good example. You can lay out exactly how it works, why it works, and approximately how much return you expect to get.

How would you summarize your philosophy of the markets after all these years?

I think inefficiencies are there for the finding, but they are fairly hard to find.

Do you think it has gotten harder to find inefficiencies, given the increased competition?

It has gotten harder for me, but that may only be because I am older and less interested, and have more money, which makes me less motivated.

Do you have any advice for someone who wanted to pursue the markets as a challenge?

The approach that worked for me was the title of a book written much later by my ex-sister-in-law, Do What You Love and the Money Will Follow.

Anything else?

Try to figure out what your skill set is and apply that to the markets. If you are really good at accounting, you might be good as a value investor. If you are strong in computers and math, you might do best with a quantitative approach.

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