GUEST AUTHOR BLOG: Know Your Opponent by Michael Goodkin, author of "The Wrong Answer Faster: The Inside Story of Making the Machine that Trades Trillions."

When I was 15, I was enough of a consistent card game winner that a neighborhood Chicago bookmaker bankrolled me for the summer to play in the bigger stakes games with the older players in return for half my winnings. Fifteen years later I was living in London and playing professional backgammon on the international circuit. In between, I used my flair for gambling to revolutionize one of the greatest betting games of all time - by founding the company that introduced computerized trading on Wall Street.

This wasn’t the stretch that on first blush it might appear. It all revolves around the single most important factor in winning a game of chance: knowing your opponent. Everybody knows the rules, the odds and the moves. Like a good trial lawyer who doesn’t ask a question for which he doesn’t already know the answer, a good gambler doesn’t make a move without first anticipating his opponent’s reaction.

That is what set me apart from the other players. I had a knack for anticipating what my opponent was going to do before he did it. Little things, like did he turn down an otherwise acceptable raise because he was on a losing streak? Did he telegraph holding a winning hand by stacking up his chips? When behind in the game did he tend to make reckless bets in hopes of getting even?

By the end of summer I won enough to return my bankroller’s stake plus a hefty return on his investment. As there wasn’t much action during the school year, I used my share of the profits to invest in the stock market and get rich just like in the movies. 

It wasn’t long before I realized that the market wasn’t an investment. It was a gamble — and a bad one at that. Not only did none of the so-called experts know the right price for anything, worst of all, playing the market was like playing an invisible opponent. There was nobody to anticipate. I took my loses and vowed to never again play the market.

Ten years later, in 1968, about to graduate from Columbia University in New York, I by chance noticed that there were no computers on Wall Street. Not that I knew much about computers – except that they went fast, the notion occurred to me that since no one knew the right price for anything, perhaps the way to beat the market was not by trying to come up with the right answer but rather by using a computer to come up with the wrong answer faster than the next guy.

But who was the next guy? The market was this invisible hand. I still needed an opponent. As it happened, while attending Columbia I learned something about an obscure investment technique known as arbitrage. Practiced by a handful of arbitrageurs working for the biggest firms on Wall Street, for all practical purposes, these arbitrageurs were the market. More importantly, they all followed the same investment formula.

Now I had an opponent. The rest was comparatively simple. I organized a company that converted their betting habits into a mathematical formula. After plugging it into a computer, we could predict the arbitrage market.

No matter if the arbitrageurs were right or wrong. All that mattered was that under certain circumstances they could be relied upon to make predictable bets. Our computer automatically bought before they laid down their bets and took its profit after their bets drove up the price. Not much different than playing winning poker because I knew what my opponent was going to do before he did it.

By Michael Goodkin, author of The Wrong Answer Faster: The Inside Story of Making the Machine that Trades Trillions (Wiley), the incredible true story behind the introduction of computerized trading on Wall Street from the man who began it all, offering the previously untold, firsthand account of one of the greatest revolutions in financial history.

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