Kelly Criterion: Mathematical Position Sizing for Traders
The Kelly Criterion calculates the optimal position size based on win rate and payoff ratio. Learn the formula and why full Kelly is too aggressive.
What Is the Kelly Criterion?
Developed by John Kelly at Bell Labs in 1956, the Kelly Criterion calculates the optimal fraction of your bankroll to risk on each trade to maximise long-term growth. The formula: Kelly % = W - (1-W)/R, where W = win rate, R = win/loss ratio.
The Formula
Kelly % = W - [(1-W) / R]. W = win probability (e.g., 0.55 for 55% win rate). R = average win / average loss (e.g., 2 if you win 2× what you lose). Example: W=0.55, R=2 → Kelly = 0.55 - (0.45/2) = 0.55 - 0.225 = 0.325 = 32.5% of bankroll per trade.
Why Full Kelly Is Too Aggressive
Full Kelly maximises long-term growth but produces enormous drawdowns. A 32.5% position size means one losing trade drops your account by a third. Most professional traders use 'Fractional Kelly' — typically 0.25× or 0.5× Kelly. Quarter Kelly (8% per trade) is still aggressive but survivable.
Practical Application
(1) Calculate your win rate and average win/loss from 100+ trades. (2) Plug into Kelly formula. (3) Multiply by 0.25 (quarter Kelly). (4) This is your maximum risk per trade. (5) If Kelly gives a negative number, your strategy has no edge — don't trade it.
Disclaimer: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 70-80% of retail investor accounts lose money when trading CFDs. Backtesting does not guarantee future results. Always consider whether you can afford the potential loss of your capital.