Kelly criterion
The Kelly criterion is a formula for the share of capital to risk on a trade to maximise long-run growth. In practice traders use a fraction of it.
How it works
John Kelly derived the formula in 1956 in information theory, and it was later applied to betting and investing. For trading it is often written as f = W − (1 − W) / R, where W is win rate, R is average win divided by average loss, and f is the share of capital at risk per trade.
If f comes out zero or negative, the strategy has no edge and should not be traded. If it is positive, it is the theoretical maximum for fastest growth. Risking more than that actually lowers long-term growth and sharply raises the risk of ruin.
Full Kelly produces very deep drawdowns, and in real life you only know your win rate and R roughly. An estimation error easily turns the 'optimal' risk into too much. So traders use half or quarter Kelly and still cap risk per trade at a sensible level.
Win rate 50%, average win twice the average loss (R = 2). f = 0.5 − 0.5 / 2 = 0.25, so full Kelly is 25% of capital at risk on each trade. That is far too aggressive for real trading: quarter Kelly is about 6%, and many traders still find that high and prefer 1–2%.
The mistake is plugging in a win rate and R from a dozen lucky trades and betting full Kelly. Small-sample estimates are almost always too optimistic, and that risk leads to huge drawdowns. Treat Kelly as an upper limit and trade a fraction of it, never above your own risk-per-trade rule.
Questions and answers
What is the Kelly criterion in simple terms?
It is a formula that suggests what percentage of capital to risk on a trade so your capital grows fastest over the long run.
How do you calculate the Kelly criterion?
f = W − (1 − W) / R, where W is win rate and R is average win divided by average loss. With W = 0.5 and R = 2 you get 25%.
Why do traders not use full Kelly?
It brings very large drawdowns and is sensitive to errors in win rate and R. Half or quarter Kelly grows more slowly but far more smoothly.
Related terms
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Updated: 2026-10-19