Kelly criterion

What it is

John Kelly's 1956 formula gives the fraction of capital to risk per bet that maximises long-run growth: f = W − (1 − W) ÷ R, where W is the win rate and R the average win ÷ average loss. A strategy winning 50% with a 2:1 payoff gives f = 0.5 − 0.5 ÷ 2 = 25%.

Full Kelly assumes you know W and R exactly, which you never do, and it produces very deep drawdowns. Traders who use it typically take a fraction such as half or a quarter Kelly, and even that is usually far above the 0.5–1% per trade that suits a prop account.

How to spot it

• Use your journal's win rate and average win and loss, over a decent sample.

How to use it

• Treat Kelly as a ceiling, not a target: if your risk per trade is above it, you're over-betting.
• For prop accounts, size from the drawdown limit first.

Common mistakes

• Using full Kelly from a short, lucky sample.
• Forgetting that estimates of W and R are uncertain.

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