Kelly Criterion
A formula giving the position size that maximises the long-run growth rate of capital.
Formula
Optimal Fraction = (Win Probability x Payoff Ratio - Loss Probability) / Payoff Ratio
Unit
%
In depth
Kelly maximises the expected logarithm of wealth, which is the mathematically correct objective for someone compounding over many periods, and it produces position sizes far larger than most practitioners are willing to hold. Its inputs are the win probability and payoff ratio, which in markets are estimated with considerable error, and overestimating them produces sizes that are catastrophically too large. Most practitioners therefore use a fraction of Kelly — a half or a quarter — which sacrifices some growth for a large reduction in drawdown. Full Kelly is theoretically optimal and practically unlivable, with drawdowns exceeding 50% as a routine occurrence.
Worked example
A 45% win rate with wins twice the size of losses gives (0.45 x 2 - 0.55) / 2 = 0.35 / 2 = 17.5% of capital per position. Half Kelly would be 8.75%, and most disciplined traders risk under 2%.
Illustrative figures, chosen so the arithmetic is easy to follow. Not a live price and not a valuation of any company.
Educational reference only
This entry explains what “Kelly Criterion” means. It is not investment advice and not a recommendation to buy or sell any security. Any numbers above are illustrative, not live prices, and nothing here predicts price direction or rates a stock. Consider your own circumstances and consult a SEBI-registered investment adviser before acting.