Stock Market · Risk Management & Psychology

Kelly criterion

The Kelly Criterion is a mathematical formula for determining optimal bet size to maximise long-term capital growth. It's the theoretical answer to 'how much should I bet on each trade?'

The Kelly formula

Kelly % = W − [(1 − W) / R]

Where:

W = win probability (as decimal, e.g., 0.6 for 60%)

R = risk-reward ratio (reward divided by risk)

Example

Your strategy: 55% win rate, average win = ₹400, average loss = ₹200 (R = 2).

Kelly % = 0.55 − [(1 − 0.55) / 2] = 0.55 − 0.225 = 0.325 = 32.5%

The formula's answer: 32.5% of capital per trade produces the fastest theoretical growth.

Why almost no one uses full Kelly

Full Kelly produces enormous drawdowns. A 32.5% position size means a single loss is catastrophic emotionally.

> Practitioners use 'half Kelly' or 'quarter Kelly'. Half or a quarter of the theoretical optimal. Still aggressive, but survivable.

The bigger lesson

Kelly tells you a profound truth: the more uncertain your edge, the smaller you should bet. If you're not sure of your win rate or R:R, your Kelly % approaches zero. Meaning you shouldn't be betting at all.

Practical use

Most retail traders skip Kelly and use the simpler 2% rule. Kelly is more useful when:

• You have accurate, backtested win-rate and R:R data
• You want to scale up positions when edge is statistically confirmed

Full Kellymathematically optimal but emotionally brutal

Half Kellythe professional standard

2% rulesafer practical alternative

Takeaway. Kelly Criterion calculates theoretically optimal bet size. Most practitioners use half Kelly to balance growth vs drawdown. Bigger lesson: uncertain edge = smaller bets. No clear edge = don't bet.