The Kelly Criterion

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. Tactical Asset Allocation - TAA

    An active management portfolio strategy that rebalances the percentage ...
  6. Portfolio Management

    Portfolio Management is the art and science of making decisions ...
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. Markets

    The (Expected) Market Impact of the 2016 Election

    With primary season upon us, investor attention is beginning to turn to the upcoming U.S. presidential election.
  6. Term

    How Statistical Significance is Determined

    If something is statistically significant, it’s unlikely that it happened by chance.
  7. Economics

    3 Charts All Investors Should See

    Given the abysmal start to the year, the defining question is whether this is another painful but temporary correction, or the start of a bear market.
  8. Investing

    2 Opportunities Amid Today’s Market Volatility

    As you prepare your portfolio for the market volatility ahead this year, here are a few investing ideas to consider.
  9. Mutual Funds & ETFs

    (EWT, FTW, QTWN) 3 Best Taiwan ETFs for 2016

    Examine detailed analysis of three exchange-traded funds that track the Taiwan equity market, and learn about the characteristics and suitability of these ETFs.
  10. Mutual Funds & ETFs

    (ENOR, NORW) 2 Best Norway ETFs for 2016

    Learn about the top two exchange-traded funds, or ETFs, that track the Norway equity market, and explore analyses of their characteristics and suitability.
RELATED FAQS
  1. Do plane tickets get cheaper closer to the date of departure?

    The price of flights usually increases one month prior to the date of departure. Flights are usually cheapest between three ... Read Full Answer >>
  2. Is Colombia an emerging market economy?

    Colombia meets the criteria of an emerging market economy. The South American country has a much lower gross domestic product, ... Read Full Answer >>
  3. 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 >>
  4. 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 >>
  5. 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 >>
  6. 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 >>
Hot Definitions
  1. Black Swan

    An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult ...
  2. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  3. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
  4. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
  5. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
Trading Center