Kelly Criterion Calculator

The Kelly criterion is an advanced money management method that helps traders determine what proportion of their trading capital should be invested in a particular position. The approach underlying the calculation takes into account the performance of previous trades. The method can be applied either to individual trades or to the allocation of capital shares to specific sectors or industries.

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.

Risk per trade

In risk management at single position level and the risk parameterization usually associated with it, the Kelly value can be included in the considerations as a guideline value. For trading strategies characterized by a high frequency and short holding period, the Kelly criterion should be used with caution. Here, unwanted successive loss series can cause the available capital to melt away disproportionately fast. For conservative investments that tend to have medium to long-term time horizons, it is a good indicator to diversify the portfolio and allocate capital to specific assets.

In general, the Kelly criterion should not be used as the sole method for determining position size and risk tolerance. Regardless of formulas and calculation methods, a maximum tolerable risk should always be determined and adhered to by the trader in relation to the individual transaction. For example, if the Kelly value suggests a risk tolerance of 50%, but the trader's own risk appetite is well below that, the more conservative approach to risk management should apply.