The calculation of the Kelly criterion includes two main factors: the probability of winning and the win-loss ratio of the trading strategy. The win probability (P) is calculated as the quotient of the total number of winning trades and the total number of all trades. The win-loss ratio (R) is the ratio of total trading wins to total trading losses.
The Kelly formula is:
Kelly % = P - [(1 - P) : R]
As an example, let's say one has won 40 out of 100 trades and the total win is €6,000 while the total losses are €2,000. This gives a win probability (P) of 0.4 and a win-loss ratio (R) of 3. Putting these values into the Kelly formula gives a Kelly percentage of 20%. This means that a maximum of 20% of trading capital can be risked in a trade.
It is important to note, however, that the Kelly criterion serves as a guideline and not an absolute rule. All positioning and risk management decisions should always be made with a pre-determined maximum risk in mind. If the Kelly criterion suggests a higher risk than the personal risk tolerance level, this should be ignored and the personal risk level maintained instead. This is especially important to protect the portfolio from unintended losses.