The Kelly Formula

What is the Kelly criterion (or formula)? It is a formula for calculating how much to bet. It assumes that your objective is long term capital growth (getting rich). The handicapper's choice of money management strategy is similar to the stock market choice between growth stocks and income stocks. Growth stocks tend to be more volatile, but in the long term return more profit. That is because the profits from growth stocks are reinvested rather than skimmed off. Every reinvestment is a calculated risk. Therefore, income stocks tend to fluctuate in value less, but also return less profit in the long term. Kelly betting is for growth. It reinvests profits, and thus puts them at risk. If your objective is to make small but consistent profits, it may be too aggressive a money management scheme.

The Kelly's formula is :

Kelly % = W - (1 - W) / R

where:

• Kelly % = percentage of capital to be put into a single trade.
• W = Historical winning percentage of a trading system.
• R = Historical Average Win/Loss ratio.

According to Kelly's formula and backtest, the daily bet of my trading system should be:

Kelly % = 52.84% - (1 - 52.84%) / 1.1 = 9.97%

That is way too aggressive! The current daily bet (risk) in my TCT Futures test is less than 3% (< $10,000).