What It Is
The Kelly Criterion is a mathematical formula for optimal bet sizing. It calculates the ideal percentage of your capital to risk on each trade based on your win rate and reward-to-risk ratio, maximizing long-term growth while minimizing the chance of ruin.
The formula: Kelly % = W - (1-W)/R, where W is your win rate and R is your average win/loss ratio. If you win 55% of the time with a 2:1 reward-to-risk, Kelly suggests risking about 32.5% per trade.
Critical caveat: Full Kelly is extremely aggressive and assumes perfect knowledge of your edge. Most professional traders and fund managers use Half Kelly or Quarter Kelly β risking 50% or 25% of the Kelly-recommended amount β to account for uncertainty and variance.
Practical Application
Kelly is useless without accurate win rate and reward/risk stats from at least 50-100 trades. Using estimated or hoped-for numbers will give you dangerously wrong sizing.
Even with reliable data, full Kelly creates uncomfortable drawdowns. Half Kelly captures about 75% of the growth rate with significantly smoother equity curves.
For most traders, Kelly serves better as a ceiling than a target. If Kelly says risk 10% and your normal risk is 1-2%, it confirms you have room to size up slightly. If Kelly says 2% and you're risking 5%, you're overexposed.
Full Kelly is academic β no one uses it in practice. Use Quarter Kelly (risk 25% of what the formula suggests) as your ceiling. This gives you 56% of the theoretical growth rate with dramatically smoother equity.
Continue through core concepts
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