What is kelly criterion?

What it means

For a binary outcome the fraction is the win probability minus the ratio of losing to winning payoff. It is mathematically optimal for growth given exact knowledge of the edge, which is the assumption that makes it dangerous in trading.

Why it matters

Full Kelly produces enormous position sizes and correspondingly enormous drawdowns — swings of 50% or more are normal at the theoretically optimal fraction. More importantly, the formula assumes the edge is known exactly, and a trading edge is estimated from a sample and changes over time.

What this changes in practice

Practitioners who use it at all use a fraction of it, commonly a quarter or less, and treat the output as an upper bound rather than a target. Our fixed 1.5% is far below any Kelly estimate our numbers would produce, which is deliberate: the estimate is built on roughly ten trades per month, and sizing aggressively against a number that uncertain is how a working system produces a blown account.