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  • Will You Add? - Kelly Criterion for Stock Trading Size

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    r odds: The total positive trade amounts divided by the total negative trade amounts.

    If you think of b as the odds of b-to-1, payout of b when betting 1 unit of money, the numerator is simply the

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    I’m sure some people know about Efficient Frontier, but I’m guessing that there are less investors that know about Kelly Criterion. So what is Kelly Criterion and who is Kelly? Kelly worked at AT&T, and published his original paper back in 1956. Its math is quite involved with communication and information theory, mostly dealing with probabilities. However, behind all the maths, there lies an astonishing result: by placing bet amounts according to Kelly Criterion (originally applied to horse-race gambling), one can maximize the returns in the long term. Here is the betting formula which has been tailored to stock trading:

    K% = ( (b+1) * p - 1) / b = ( b*p - (1-p) ) / b Win probability (p): The probability that any given trade you make will return a positive amount.

    Win/loss ratio (b) or odds: The total positive trade amounts divided by the total negative trade amounts.

    If you think of b as the odds of b-to-1, payout of b when betting 1 unit of money, the numerator is simply the

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    ublished his original paper back in 1956. Its math is quite involved with communication and information theory, mostly dealing with probabilities. However, behind all the maths, there lies an astonishing result: by placing bet amounts according to Kelly Criterion (originally applied to horse-race gambling), one can maximize the returns in the long term. Here is the betting formula which has been tailored to stock trading:

    K% = ( (b+1) * p - 1) / b = ( b*p - (1-p) ) / b Win probability (p): The probability that any given trade you make will return a positive amount.

    Win/loss ratio (b) or odds: The total positive trade amounts divided by the total negative trade amounts.

    If you think of b as the odds of b-to-1, payout of b when betting 1 unit of money, the numerator is simply the

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    result: by placing bet amounts according to Kelly Criterion (originally applied to horse-race gambling), one can maximize the returns in the long term. Here is the betting formula which has been tailored to stock trading:

    K% = ( (b+1) * p - 1) / b = ( b*p - (1-p) ) / b Win probability (p): The probability that any given trade you make will return a positive amount.

    Win/loss ratio (b) or odds: The total positive trade amounts divided by the total negative trade amounts.

    If you think of b as the odds of b-to-1, payout of b when betting 1 unit of money, the numerator is simply the

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    o stock trading:

    K% = ( (b+1) * p - 1) / b = ( b*p - (1-p) ) / b Win probability (p): The probability that any given trade you make will return a positive amount.

    Win/loss ratio (b) or odds: The total positive trade amounts divided by the total negative trade amounts.

    If you think of b as the odds of b-to-1, payout of b when betting 1 unit of money, the numerator is simply the

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    r odds: The total positive trade amounts divided by the total negative trade amounts.

    If you think of b as the odds of b-to-1, payout of b when betting 1 unit of money, the numerator is simply the mean value of expected payout, or the so-called “edge”. Therefore, K% can be expressed as edge/odd. For obvious reason, you don’t want to bet in any game where the expected payout is 0 or negative.

    If Kelly Criterion is so great, why is that this is not heard or used very often in the investing world. There are a couple of reasons that prevent it to be used practically:

    1. The volatility of strictly using Kelly Criterion is quite big. Despite that in the long term, probabilistically speaking your portfolio will have the maximum return possible, the ups and downs are too big to be digested by most people. Therefore, people talk about using “half Kelly” or half of the bet amount calculated from Kelly Criterion in attempt to reduce the portfolio volatility.
    2. To use Kelly Criterion, it req

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