A mathematical formula used to determine the optimal bet or investment size to maximize long-term wealth growth. It calculates the exact fraction of your bankroll to risk on a trade by weighing your historical winning probability against the size of your potential wins and losses.
For investments and trades with standard odds:
- = The optimal fraction of your capital to allocate to a single trade.
- = Probability of winning.
- = The win/loss ratio (Average winning trade divided by average losing trade)
Maximizing Growth: The Kelly Criterion dictates betting only a portion of capital, which optimally balances the risks of ruin against the rewards of compounding.
Scaling by Volatility: If an asset is highly volatile, the formula dictates a smaller stake, protecting your capital against severe draw-downs.