📍 Core Concept

Kelly Criterion

Mathematical formula for optimal position sizing based on edge and win rate.

APOLLO ENCYCLOPEDIA

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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 — risking 50% or 25% of the Kelly-recommended amount — to account for uncertainty and variance.

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Practical Application

You need real data first.

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.

Use Half Kelly maximum.

Even with reliable data, full Kelly creates uncomfortable drawdowns. Half Kelly captures about 75% of the growth rate with significantly smoother equity curves.

Strategy 3

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.

💡Pro Tip

Full Kelly is academic — 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.

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