What Is the Kelly Criterion?
The Kelly Criterion is a mathematical formula developed by John Kelly at Bell Labs in 1956. Originally designed for signal transmission, it was quickly adopted by gamblers and later traders to determine the optimal fraction of capital to risk on each bet.
The Formula
For example: 55% win rate, 1.5:1 win/loss ratio → Kelly = 0.55 − (0.45/1.5) = 0.55 − 0.30 = 25%
Why Traders Use Half Kelly
Full Kelly maximizes long-term geometric growth mathematically, but in practice it leads to enormous drawdowns. The variance is brutal. Most professional traders and funds use Half Kelly (12.5% in our example) or Quarter Kelly.
Half Kelly achieves about 75% of the growth rate of Full Kelly while cutting drawdown variance dramatically. This is the real-world optimal for most applications.
The Danger of Overkill
Many traders misapply Kelly because they overestimate their win rate or average win. If your inputs are wrong, Kelly will tell you to over-bet. Generally, use conservative estimates and consider using Half or Quarter Kelly as a safety margin.
Kelly in Practice
Professional traders run their system statistics over 100+ trades before applying Kelly. With fewer samples, the estimates are too noisy to trust. Until then, stick to the simple 1-2% rule.
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