What is the Kelly Criterion?
The Kelly Criterion is a mathematical formula used to determine the optimal size of a series of bets or investments. It was developed by John L. Kelly Jr. in 1956 and is widely used by investors and gamblers to maximize the long-term growth rate of their capital while avoiding the risk of ruin.
How it Works
The formula calculates the percentage of your capital that should be allocated to a specific opportunity based on the probability of winning and the risk/reward ratio.
The Formula Used:Kelly % = (Win Probability / Loss on Loss) - ((1 - Win Probability) / Gain on Win)
Why is it Important?
- Maximizes Growth: Mathematically proven to deliver the highest compounded growth rate over the long term.
- Manages Risk: Adjusts position sizes based on the "edge" you have. If the edge is small, the position size is small.
- Prevents Ruin: Theoretically, if you follow the Kelly Criterion precisely, you should never lose your entire bankroll (though in practice, fractional Kelly is often used to smooth out volatility).
How to Use This Calculator
- Enter Total Capital: Input the total amount of money you have available for investment or betting.
- Enter Win Probability: Estimate your chance of winning (0-100%).
- Enter Gain on Win: Input the percentage profit you expect if you win (e.g., 40% means a $100 bet returns $140 total, or $40 profit).
- Enter Loss on Loss: Input the percentage of your bet you expect to lose if you are wrong (usually 100% for simple bets, or a stop-loss percentage for trading).
- Calculate: Click the button to see the optimal allocation percentage and dollar amount.
Disclaimer: This tool is for informational purposes only. Trading and investing involve significant risk. The Kelly Criterion is a theoretical model and does not guarantee future results. Always consider your personal risk tolerance and financial situation.
Frequently Asked Questions
What is "Fractional Kelly"?
Fractional Kelly involves betting a fraction (e.g., half or quarter) of the recommended Kelly percentage. This is often done to reduce the volatility of the portfolio and provide a psychological safety margin, as full Kelly betting can be very volatile.
What if the Kelly Percentage is negative?
A negative Kelly percentage means the investment has a negative expected value. In other words, the odds are stacked against you, and the optimal strategy is to not invest at all.