The Kelly Criterion Shocks Some and Inspires Others

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Hey there Mike. I was reading the hedge fund Market Wizards where the Kelly criterion was mentioned. To be honest it shocked me that any professional trader would take it seriously. It seems like it directs the trader to risk far more money than any professional trader would ever dare to risk. It tells the trader to risk as much as 20 to 30% of his trading account Mike! This sounds like trader suicide to me. Even after applying the “conservative” method of cutting it in half as one trader in the book suggested you would still be risking 10 to 15% of your trading account on each trade which again is far more than any professional I have heard of risks on his trades. As best I can tell, the Kelly criterion is a totally useless formula for serious traders and I can’t figure out how it even made it into the book. The only professional I have ever heard of who suggests such large bets is Larry Williams in his book in which he advises risking over 10% for some traders which shocked me when I read that book. I was just wondering what are your thoughts on the Kelly criterion?

Dave Druz and Ed Seykota wrote a good piece called “Determining Optimal Risk”. Worth a read if you haven’t checked it out already. Kelly also discussed heavily here.

The Author