The Kelly Criterion

AAA

DEFINITION of 'The Kelly Criterion'

A mathematical formula relating to the long-term growth of capital developed by John Larry Kelly Jr. The formula was developed by Kelly while working at the AT&T Bell Laboratories. The formula is currently used by gamblers and investors to determine what percentage of their bankroll/capital should be used in each bet/trade to maximize long-term growth.

The Kelly Criterion

BREAKING DOWN 'The Kelly Criterion'

There are two key components to the formula: the winning probability factor (W) and the win/loss ratio (R). The winning probability is the probability a trade will have a positive return. The win/loss ratio is equal to the total positive trade amounts divided by the total negative trading amounts. The result of the formula will tell investors what percentage of their total capital that they should apply to each investment.

After being published in 1956, the Kelly Criterion was picked up quickly by gamblers who were able to apply the formula to horse racing. It was not until later that the formula was applied to investing.

RELATED TERMS
  1. Trading Capital

    The amount of money allotted to buying and selling various securities. ...
  2. Diversification

    A risk management technique that mixes a wide variety of investments ...
  3. Modern Portfolio Theory - MPT

    A theory on how risk-averse investors can construct portfolios ...
  4. Asset Allocation

    An investment strategy that aims to balance risk and reward by ...
  5. Portfolio Management

    The art and science of making decisions about investment mix ...
  6. Tactical Asset Allocation - TAA

    An active management portfolio strategy that rebalances the percentage ...
Related Articles
  1. Active Trading Fundamentals

    Money Management Using The Kelly Criterion

    Not sure how to determine your equity allocations? Read about a system that can help.
  2. Mutual Funds & ETFs

    Separately Managed Accounts: A Boon For All

    We provide an explanation of individual cost basis and the advantages it brings to these accounts.
  3. Forex Education

    Forex: Money Management Matters

    Currency trading offers far more flexibility than other markets, but long-term success requires discipline in money management.
  4. Active Trading

    Modern Portfolio Theory: Why It's Still Hip

    See why investors today still follow this old set of principles that reduce risk and increase returns through diversification.
  5. Mutual Funds & ETFs

    ETF Analysis: Vanguard Intermediate-Term Corp Bd

    Learn about the Vanguard Intermediate-Term Corporate Bond ETF, and explore detailed analysis of the fund's characteristics, risks and historical statistics.
  6. Mutual Funds & ETFs

    Top 3 Switzerland ETFs

    Explore detailed analysis and information of the top three Swiss exchange-traded funds that offer exposure to the Swiss equities market.
  7. Economics

    The Problem With Today’s Headline Economic Data

    Headwinds have kept the U.S. growth more moderate than in the past–including leverage levels and an aging population—and the latest GDP revisions prove it.
  8. Economics

    Explaining the Participation Rate

    The participation rate is the percentage of civilians who are either employed or unemployed and looking for a job.
  9. Mutual Funds & ETFs

    ETF Analysis: Guggenheim Enhanced Short Dur

    Find out about the Guggenheim Enhanced Short Duration ETF, and learn detailed information about this fund that focuses on fixed-income securities.
  10. Mutual Funds & ETFs

    ETF Analysis: iShares Morningstar Small-Cap Value

    Find out about the Shares Morningstar Small-Cap Value ETF, and learn detailed information about this exchange-traded fund that focuses on small-cap equities.
RELATED FAQS
  1. What assumptions are made when conducting a t-test?

    The common assumptions made when doing a t-test include those regarding the scale of measurement, random sampling, normality ... Read Full Answer >>
  2. What are some of the more common types of regressions investors can use?

    The most common types of regression an investor can use are linear regressions and multiple linear regressions. Regressions ... Read Full Answer >>
  3. What types of assets lower portfolio variance?

    Assets that have a negative correlation with each other reduce portfolio variance. Variance is one measure of the volatility ... Read Full Answer >>
  4. When is it better to use systematic over simple random sampling?

    Under simple random sampling, a sample of items is chosen randomly from a population, and each item has an equal probability ... Read Full Answer >>
  5. What are some common financial sampling methods?

    There are two areas in finance where sampling is very important: hypothesis testing and auditing. The type of sampling methods ... Read Full Answer >>
  6. How can I measure portfolio variance?

    Portfolio variance measures the dispersion of returns of a portfolio. It is calculated using the standard deviation of each ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Stock Market Crash

    A rapid and often unanticipated drop in stock prices. A stock market crash can be the result of major catastrophic events, ...
  2. Financial Crisis

    A situation in which the value of financial institutions or assets drops rapidly. A financial crisis is often associated ...
  3. Election Period

    The period of time during which an investor who owns an extendable or retractable bond must indicate to the issuer whether ...
  4. Shanghai Stock Exchange

    The largest stock exchange in mainland China, the Shanghai Stock Exchange is a nonprofit organization run by the China Securities ...
  5. Dead Cat Bounce

    A temporary recovery from a prolonged decline or bear market, followed by the continuation of the downtrend. A dead cat bounce ...
  6. Bear Market

    A market condition in which the prices of securities are falling, and widespread pessimism causes the negative sentiment ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!