Bringing Down The House (Ben Mezrich) 0 comments

In fact, this is by most definitions not a book about investing or the stock markets. This is a book about gambling --- how a group of MIT (Massachusetts Institute of Technology) students won millions at the casinos in just a few years in a game in which they had found a loophole .... thus the title of the book.

The game was blackjack, and it is now widely acknowledged as the casino game where the house odds are negative, if you play your cards right. House odds, basically, are the marginal probabilistic advantage that the casino (or banker) typically holds over the players (casino customers) in most casino games (eg. in roulette, there are 37 numbers including the green "0" but the house only pays 36-to-1 for a number you guess correctly); in the long run, this means the casino should transform this marginal advantage to a financial gain.

Those who have heard of card-counting will know that it's a way of beating the odds in blackjack. Based on countless computational simulations by university professors, the technique at its essence is about monitoring the cards that have been dealt out and taking advantage of what it suggests about the cards remaining in the deck. Typically, a remaining deck containing many high cards (tens, pictures, Aces) is advantageous for the player; conversely, a remaining deck rich in low cards (2-5s) is advantageous for the dealer. All card-counting techniques are based on this principle.

The book, set in the mid-1990s, essentially is about a group of MIT students and alumni who refined this into an art form, by working in teams (and all the associated secret signals and jargon), maximising table opportunities, and running the money-spinning operations like a business by using other people's money (their rich "investors" were offered 20-30% returns on their money). The scale of their winnings? Several hundred thousand dollars for a team of ten for every 2-3 day trip to the casino stretch eg. Las Vegas.

Why am I highlighting this book here? Several reasons. Firstly, I have always believed there are some similarities between gambling and investing/trading on the markets. See my article on "Gambling and Investing". Both are essentially about probabilities --- in investing we know it as the "upside potential" and the "downside risk". You pick games/stocks that offer the best risk/reward ratio, and you press your advantage when things are good. For gambling, card counting enabled the MIT teams to identify opportunities when the odds were on their side .... and they put down heavy money in these cases. Of course, there were times when things turned out bad despite the odds, but overall they made money big-time. Card counting is a prime example of risk management in gambling, betting big money when the odds are good is a prime example of money management, the whole approach reflects a scientifically and logically coherent approach to gambling (hitherto known as a long-term losing proposition for the gambler). All these lessons can easily apply to investing.

The second reason is the interesting way in which both sides --- the MIT teams and the casinos --- think they are justified in their stance, reflecting a classic moral dilemma which draws parallels to many real-life situations. The MIT teams believed they were well within their legal rights to make money through card-counting, since the law did not prohibit that. The casinos, however, lumped card counters together with common cheaters (ie. those who slipped cards into their hand, or marked cards illegally) and took increasingly tough action towards them (from banning further entry to manhandling them). There is validity in both stands: one can say the card counters were just making use of their intelligence to beat the odds, and beating the odds surely is not illegal!? On the other hand, the casinos saw it as their right to protect their interests (especially when big money is involved) and since the casino was their property, they could ban unwelcome visitors --- which they did eventually. If one looks at the real world, everybody preaches free markets, but aren't there many practices that are designed to limit the degree of freedom with which businesses operate? Trade protectionism, anti-trust laws against mergers, rules against cartel formation --- all examples. So there are all-encompassing principles, limited by institutionalised rules, and if the casinos dictate no card-counters in their premises, then the MIT teams had to respect that. This state of greyness spills over to the stock markets. With insider trading technically illegal, many company directors still accummulate obviously knowing new developments outsiders don't. Why is window-dressing considered standard practice while other forms of market manipulation are considered chargeable offences? Aren't there conflicts of interest with the profit-oriented stock exchange being itself a market regulator? The answer is that there will always be grey areas and limiting rules set by governing institutions (the "bankers") and while short-term gains can be made by skimming the edges, it is seldom scaleable if it goes against the "spirit of the game".

The last reason why I highlight the book is that simply, it is a good read. Check it out and don't forget the last chapter on the technical aspects of card-counting. Maybe it might come in handy next time at the casino!