Kelly Criterion

The Kelly Criterion is a position-sizing formula developed by John Kelly at Bell Labs in 1956. It calculates the optimal percentage of your account to risk on each trade, given your win rate and average reward-to-risk ratio. The math: f = (bp − q) / b, where b = reward/risk ratio, p = win rate, q = loss rate. If you have a 55% win rate and a 2:1 reward-to-risk, full Kelly says risk 32.5% of your account per trade. That number sounds insane — and it is. Kelly is the GROWTH-OPTIMAL bet size, but it also produces 50%+ drawdowns regularly. Real traders use HALF KELLY or QUARTER KELLY (8% or 16% of full Kelly) to capture most of the growth with much less drawdown pain. Kelly assumes you know your edge precisely. In real trading, your edge estimates are noisy, so always size below what Kelly says. "Quarter Kelly" is the institutional standard.