Kelly Criterion & Risk Of Ruin As Risk Management Tool

This implies that a wager made at these odds has a 50 informative post % percent chance of winning. If the investor believes that a wager has more than a 50% probability of winning, in that case, it has a positive expected value. Professional betting—whether gambling, investing, or handicapping—is about having an advantage with a positive expected return. If you don’t have any statistical edge, you shouldn’t bet at all.

Kelly Criterion In Detail

The Kelly Criterion – also known as Kelly Strategy or Kelly Staking Plan – takes elements from Fixed, Percentage and Progressive staking to create somewhat of a hybrid staking plan. I will have to run “permutations using macros” which basically means running all possible combinations that a series of 100 trades could play out, weighted by their probability of occurring. From there you can add up all events where the total bankroll as a result of those trades at given bet size adds up to a certain threshold lost. It will probably be a few months until I get around to getting the spreadsheet to that point since I have other things to tend to.

Final Thoughts On Kellys Criterion & Horse Racing

Kelly Criterion is a formula that is applied to find out the optimal sum of money that is suitable to be invested on a certain occasion. It takes into account the total sum of money that is accessible to use, as well as the expected return. Developed by a research worker at Bell Labs named John Kelly.

Does this mean that we should always try and stretch for the Kelly optimal point as long as we’re on the left side of the curve? In the vast majority of cases, especially in investing, it actually makes sense to err on the side of caution and underbetting may be the right strategy in the long run. To understand why that is, we can now introduce another mental model by the name of “law of large numbers”.

Below we have a parlay calculator and also some more information about parlays in general. However, as you may have guessed, in casinos and in gambling in general, you will probably never find a situation where you are a consistent favourite to win in an even-money bet. This is because casinos only offer see post games where the house has an advantage over the players. By making the bet sizing a percentage of your available funds, the chances of complete financial ruin drop to zero as you will never bet all your available funds on a single bet. The average across the four is $110.25, reflecting the compound 5% growth. As the number of flips increases, the proportion who lose money increases, with a rarer but more extraordinarily rich cohort propping up the average.

All odds quoted correct at time of publishing and subject to change. So we can see that this aggressive strategy is almost surely 5 going to result in ruin. Note that although the Kelly Criterion provides an upper bound on the amount that should be risked, there are sound arguments for risking less. In particular, the Kelly fraction assumes an infinitely long sequence of wagers — but in the long run we are all dead. It can be shown that a Kelly bettor has a 1/3 chance of halving a bankroll before doubling it, and that you have a 1/n chance or reducing your bankroll to 1/n at some point in the future.

You might not turn millionaire years from now, but a definite takeaway from our analysis is how helpful a systematic approach can actually be everywhere where statistical information can easily be extracted. You still need a healthy degree of understanding as to what’s what and how to adequately estimate the chances of winning – the software will take care of the rest. Be sure to carefully input the variables manually and doublecheck them before hitting the magic “calculate” button. Also, remember to always judge on the merits of an asset or a bet regardless of what Kelly says.

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Staking

Unfortunately, given our take it or leave it choice we opened with involving 40% of our wealth, we can’t use the Kelly Criterion to optimise the bet size and should refuse the bet. If we plot the simulation for, say, 1,000 periods rather than 100, there are few winners. Here’s a plot of the average wealth of the population for 1000 periods , plus a log plot of that same growth .