A mathematical formula that calculates the optimal bet size based on win rate and reward-to-risk — used to maximize long-term growth.
The Kelly Criterion is a position-sizing formula developed by John Kelly at Bell Labs in 1956. It calculates the optimal percentage of your account to risk on each trade, given your win rate and average reward-to-risk ratio. The math: f = (bp − q) / b, where b = reward/risk ratio, p = win rate, q = loss rate.
If you have a 55% win rate and a 2:1 reward-to-risk, full Kelly says risk 32.5% of your account per trade. That number sounds insane — and it is. Kelly is the GROWTH-OPTIMAL bet size, but it also produces 50%+ drawdowns regularly. Real traders use HALF KELLY or QUARTER KELLY (8% or 16% of full Kelly) to capture most of the growth with much less drawdown pain.
Kelly assumes you know your edge precisely. In real trading, your edge estimates are noisy, so always size below what Kelly says. "Quarter Kelly" is the institutional standard.
Edward Thorp, the math professor who beat Vegas blackjack, used the Kelly Criterion to grow his hedge fund Princeton Newport Partners by 19% per year for 19 years with very low drawdowns — the discipline of fractional Kelly was the secret.
Frequently asked about kelly criterion
What is a kelly criterion in trading?+
A mathematical formula that calculates the optimal bet size based on win rate and reward-to-risk — used to maximize long-term growth.
When will I see kelly criterion used in real trading?+
In serious quant and prop trading discussions. Most retail traders ignore Kelly because the numbers it produces look terrifying.
What is the most common mistake traders make with kelly criterion?+
Using full Kelly. The formula assumes perfect information about your edge, which no real trader has. Full Kelly produces 30-50% drawdowns even on profitable systems — most traders quit before recovering.
What do experienced traders know about kelly criterion that beginners don't?+
Calculate full Kelly for your strategy, then trade at QUARTER Kelly. You'll capture about 75% of the growth with one-quarter of the drawdown. That's the sweet spot for survivable compounding.
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