The Kelly Criterion is a formula widely used in betting and investment strategies to determine the optimal size of a series of bets in order to maximize wealth over time. Originally developed by John L. Kelly in 1956 while working at Bell Labs, the Kelly Criterion has become a staple in the fields of finance and gambling.
The Kelly Criterion is based on the principle of proportional betting. Rather than betting all your money or a fixed amount on a single event, the Kelly Criterion calculates the fraction of your total capital to wager based on the probability of winning and the payout odds. By doing so, it aims to maximize long-term growth of wealth, while minimizing the risk of ruin.
The formula is expressed as:
Where:
To illustrate how the Kelly Criterion works, consider the following example:
Using the Kelly Criterion formula:
According to the Kelly Criterion, you should wager 40% of your bankroll on this bet.
The Kelly Criterion is a mathematically sound strategy for determining the optimal bet size. However, itâs important to approach it with caution, ensuring that probabilities are accurate and that the bettor is comfortable with the potential risks. For those who can tolerate short-term fluctuations, the Kelly Criterion can be a powerful tool for wealth accumulation over time.
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