## December 6, 2017

### Money Management Using The Kelly Criterion

The Kelly criterion is a formula used to determine the optimal size of a series of bets in order to maximise the logarithm of wealth. In recent years, Kelly has become a part of mainstream investment theory and the claim has been made that well-known successful investors including Warren Buffett and Bill Gross use Kelly methods.

• Win probability - The probability that any given trade you make will return a positive amount.
• Win/loss ratio - The total positive trade amounts divided by the total negative trade amounts.

These two factors are then put into Kelly's equation:
Kelly % = W – [(1 – W) / R]

Where:
W = Winning probability
R = Win/loss ratio = value of profitable trade/ value of loss making trade

Example: say you are winning 60% of the time and your Win/ Loss ratio is 1.5. Then you should invest:

Another example: say you are winning 20% of the time and your Win/ Loss ratio is 5. Then you should invest:

Last example: say you are winning 50% of the time and your Win/ Loss ratio is 2. Then you should invest: